Dealing with volatility: What you need to know now

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Timely insights to help you manage risk when markets shift.
December 5, 2018

Why the market is still volatile — and how the Fed could help

The opinions are those of the author(s) and subject to change.
The Dow's decline of nearly 800 points Tuesday signaled ongoing fears of slower economic growth, with volatility likely to continue into the new year, says Chris Hyzy, Chief Investment Officer for Merrill Lynch and U.S. Trust. "Housing weakness, wider credit spreads, and an inversion at a few points on the yield curve are all contributing to higher volatility and lower prices," he notes.
Credit spreads refer to the difference in return, or yield, between U.S. Treasury bonds and higher-risk corporate bonds of the same duration, Hyzy explains. The yield curve reflects the difference in return rates between short-term and long-term government bonds. Widening spreads and yield curve inversions (when yields for short-term bonds become higher than those for long-term bonds) both are seen as potential signs of a weakening economy.
The Federal Reserve could help stabilize markets by signaling that interest rates are at an appropriate level, but that isn't likely until next year."
— Chris Hyzy, Chief Investment Officer for Merrill Lynch and U.S. Trust
"The Federal Reserve could help stabilize markets by signaling that interest rates are at an appropriate level," Hyzy adds, "but that isn't likely until next year." Also needed: greater evidence that the U.S. and China are serious about resolving their trade differences. "Until we get confirmation in these two areas, market activity is likely to remain choppy and directionless," says Hyzy.
Investing involves risk, including the possible loss of principal.

Past performance is no guarantee of future results.

Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice versa.

International investing presents certain risks not associated with investing solely in the U.S. These include, for instance, risks related to fluctuations in the value of the U.S. dollar relative to the value of other currencies, custody arrangements made for a fund’s foreign holdings, political risks, differences in accounting procedures and the lesser degree of public information required to be provided by non-U.S. companies. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.
Please read important disclosures below.*
November 26, 2018

From the Federal Reserve to Brexit: What's behind the volatility, and what can investors do?

The opinions are those of the author(s) and subject to change.
It's been a long autumn for the markets. Each new day of volatility feels like a freshly unsettling event. But from the recent ups and downs, some clear patterns and messages are emerging, the Chief Investment Office maintains in its new Investment Insights report, "The Fed Holds the Cards."
How did we reach this point, and what might the future bring?
As the report's title indicates, one major concern for investors is whether the Federal Reserve's planned series of interest rate increases in 2019, after years of record-low rates and low inflation, could slow economic growth. "If a slowdown in growth becomes too pronounced, a pause in the Fed's rate hike plans could help stabilize investor fears," says Chris Hyzy, Chief Investment Officer for Merrill Lynch and U.S. Trust. Yet there are other prominent concerns as well, including Italy's current budget battle with the European Commission; Brexit; uncertainty about oil prices; and rising U.S.-China trade and tariff tension.
Resist the temptation to "time" markets by buying and selling in anticipation of short-term changes. "This is extremely difficult to do."
— Chris Hyzy, Chief Investment Officer for Merrill Lynch and U.S. Trust
"This extended volatility isn't the result of any single factor, but a powerful array of global forces," Hyzy says. "A short while ago, people were concerned about the economy overheating. Now they're more concerned about an economic hard landing." Those fears may be overstated, Hyzy believes. A moderate cooling down would represent "a return to normalcy" after years of unusually low growth, followed more recently by an economic surge. Even as the rate of growth slows, he adds, "We continue to believe that in 2019 the U.S. economy will grow at approximately 2.5%, with corporate earnings around 5%."
What can investors do?
During times of volatility, Hyzy advises investors to resist the temptation to "time" markets by buying and selling in anticipation of short-term changes. "Market timing requires making two decisions — when to sell and when to buy back in — at exactly the right moments," he says. "This is extremely difficult to do."
Instead, he suggests a more patient, strategic approach based on these action points:
  • Stay diversified across multiple asset classes, and recognize that higher volatility demands discipline. Rebalance your portfolio as conditions change, to be sure your original plan is in place.
  • Emphasize quality across your portfolio, and include stocks of large U.S. corporations with healthy balance sheets as well as investments offering dividend growth.
  • Don't abandon international investments. They can offer attractive valuations and other benefits for patient investors.
  • Look at ways to generate income, including cash, short-term bonds, and stocks with the potential for dividend growth.
Now may be a good time review your portfolio for the rest of the year and 2019.
For a deeper look into the current market situation and the long-term outlook for 2019, read the Chief Investment Office Investment Insights report, "The Fed Holds the Cards."
Investing involves risk, including the possible loss of principal.

Past performance is no guarantee of future results.

Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets.

International investing presents certain risks not associated with investing solely in the U.S. These include, for instance, risks related to fluctuations in the value of the U.S. dollar relative to the value of other currencies, custody arrangements made for a fund's foreign holdings, political risks, differences in accounting procedures and the lesser degree of public information required to be provided by non-U.S. companies.
Please read important disclosures below.*
November 21, 2018

Continued volatility — and what might help turn things around

The opinions are those of the author(s) and subject to change.
The stock market continued to slide this week, increasing the likelihood that market uncertainties will remain as we head into December, says Chris Hyzy, Chief Investment Officer for Merrill Lynch and U.S. Trust. Despite higher-than-expected corporate earnings during the third quarter of 2018, "concerns over economic growth for 2019 continue," Hyzy says. "Higher short-term interest rates, a widening in credit spreads, and continued trade and tariff sparring between the U.S. and China have all played a part in the recent declines."
We do not expect an economic hard landing next year, but the Fed needs to let the economy absorb the hikes already in the system."
— Chris Hyzy, Chief Investment Officer for Merrill Lynch and U.S. Trust
As with the market volatility earlier this fall, the steepest drops have been among high-growth stocks, and that weakness has affected the broader stock indices, according to the most recent "Capital Market Outlook" from the Chief Investment Office. Two actions could help investors to regain confidence in economic growth prospects for 2019, Hyzy believes.
  • First, the Federal Reserve could soften its stance on planned interest rate increases for the year ahead. "The Fed doesn't necessarily need to cut rates at the next meeting but a pause is needed, in our view. An adjustment to their communication would help ease any concerns about potential policy mistakes," he says.
  • The second imperative is an easing of trade tensions between China and the United States, Hyzy adds. "We recognize that a long-term deal is unrealistic, but even a short-term ‘bridge' agreement on tariffs and trade would significantly help investor sentiment."
Amid the ongoing volatility, investors should remain cautious in their outlook for 2019, Hyzy says. "We do not expect an economic hard landing next year, but the Fed needs to let the economy absorb the hikes already in the system," he adds. Once the markets work through the current phase of weakness, investor confidence and equity returns for 2019 could rebound to a level on par with corporate earnings growth.
Learn more about what's behind the latest volatility, and what forces could restore investor confidence in the latest "Capital Market Outlook" from the Chief Investment Office.
Investing involves risk, including the possible loss of principal.

Past performance is no guarantee of future results.

Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets.
Please read important disclosures below.*
October 30, 2018

Volatility, the economy and what to do next: Answers to your questions

The opinions are those of the author(s) and subject to change.
The broader market, as measured by the S&P 500, has fallen 8.8 percent for the month of October, to date, dipping into correction territory briefly on Friday, October 26th. And three-quarters of the stocks in the S&P 500 have corrected at least ten percent.
What's behind the current volatility, and when might we see a turnaround? What does the volatility say about the U.S. economy, and what should investors do now? In the October "Investment Insights" report, "The Digest for a Turnaround," Chris Hyzy, Chief Investment Officer for Merrill Lynch and U.S. Trust, discusses these pressing issues and his underlying confidence in the markets and the economy. You'll find an overview below.
Q: What caused this latest market correction?
A: In early October, Federal Reserve Chairman Jerome Powell signaled the potential for higher interest rates, and Vice President Mike Pence, in a separate speech, warned of rising trade tensions with China. Concerns about global growth, dollar strength, Italy's budget battles and other factors have added to volatility and fears that the current economic growth cycle is over. And technical selling, which happens automatically when the markets reach certain levels, has accelerated the correction.
Q: Why are you still positive on the U.S. economy and equities?
A: Despite these risks, the economy is strong. While some see weakness in the housing and auto sectors as signs that the U.S. economy is about to roll over, we see this more as a cyclical pause in these industries, both of which should remain attractive for years to come. We do believe U.S. economic growth will slow in 2019 but will still remain above-trend at a healthy rate around 2.6 percent or better for the full year.
We believe investors should consider diversifying stock portfolios and adding shorter-duration bonds for income and potential for volatility protection."
— Chris Hyzy, Chief Investment Officer for Merrill Lynch and U.S. Trust
Q: What should power the U.S. economy next year?
A: Spending and confidence remain high, and with more job openings than available workers, we don't see that changing. Small businesses, which drive job growth and the economy, have remained confident, and in corporate America we expect increases in productivity and profits. While the rate of earnings growth will slow from 2018's 20 percent, we expect S&P 500 earnings will rise by a still-healthy 6-7 percent in 2019.
Q: What are the main risks to the economy and the markets?
A: Geopolitical risks include recent events in Saudi Arabia, a potential power shift in Germany, and Italy's budget battle with the EU. In the U.S., the Federal Reserve seems bent on pushing rates more than the market expects in 2019 (three hikes versus two expected), and trade issues with China, and the midterm elections add to the uncertainties. While these will need to be constantly assessed in the coming weeks and months, we do not expect them to alter the growth outlook or roll the economy into a hard landing.
Q: What should investors consider?
A: We believe investors should consider diversifying stock portfolios and adding shorter-duration bonds for income and potential for volatility protection. We favor active rather than passive management strategies and high-quality U.S. stocks with strong balance sheets.
When the current volatility ends, we see long-term growth opportunities in U.S. Technology and Healthcare stocks and Emerging Markets, as well as U.S. Financials (which have over-corrected, in our view) and Industrials. While value-oriented stocks, which trailed growth in recent months, have been catching up recently, we caution against switching completely from one style to the next. We prefer a diversified mix with a slight preference toward value.
Most important is not to panic. Instead of trying to predict market bottoms, we recommend that investors focus on the fundamentals and have a strategy ready as markets begin to stabilize. We are staying the course.
Go deeper on the causes of the current volatility and what to expect next in "The Digest for a Turnaround," the latest "Investment Insights" from the Chief Investment Office.
Investing involves risk, including the possible loss of principal.

Past performance is no guarantee of future results.

Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets. Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice versa.
Please read important disclosures below.*
October 25, 2018

More volatility — but stabilization is around the corner

The markets have experienced further declines this week, driven by concerns over growth and technical selling — or, selling triggered when markets reach certain levels. Growth and momentum areas such as Technology and Industrials have led the decline, along with economically sensitive or housing-related areas such as Financials.
We believe we are in the final stages of this downdraft. While higher levels of volatility are likely to continue through the current earnings season, positive announcements in the next round of earnings are likely to help stabilize the correction and re-establish a positive trend to close out the year."
— Chris Hyzy, Chief Investment Officer for Merrill Lynch and U.S. Trust
"We see this most recent selling as a re-pricing of risk and valuation. This is a time to let the excesses from the high valuation areas settle down, have a plan ready, and then begin to invest in high quality areas that corrected too far," says Chris Hyzy, Chief Investment Officer for Merrill Lynch and U.S. Trust. S&P 500 price-to-earnings expectations for the next 12 months have corrected from approximately 19 times to about 15 times, he notes. And while U.S. equity markets are about 10% below their all-time highs from late September, valuation has corrected more than 20%.
We believe we are in the final stages of this downdraft," Hyzy says. "While higher levels of volatility are likely to continue through the current earnings season, we expect positive announcements in the next round of earnings, including from large-cap, bell-weather companies. These announcements are likely to help stabilize the correction and re-establish a positive trend to close out the year," he adds.
"We expect that corporate stock-buyback programs, which pick up speed when earnings seasons close, will lend additional stability," Hyzy notes. And the economy offers many reasons for encouragement, including positive data on jobs, consumer spending, capital expenditures growth and inflation, and calmness in the U.S. dollar. Another positive sign: As growth investments have declined, value areas are closing the performance gap to more sustainable levels. Hyzy says, "All of these factors should help improve investor confidence in the coming weeks."
Investing involves risk, including the possible loss of principal.

Past performance is no guarantee of future results.

Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets. Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice versa.
Please read important disclosures below.*
October 19, 2018

The market correction continues — and that's normal

"Thursday's market drop, following last week's sharp volatility, is part of a rolling correction rather than a surprising new development," says Chris Hyzy, Chief Investment Officer for Merrill Lynch and U.S. Trust. When markets pull back as quickly as they did last week, it takes time for internal market measurements, such as trading volume and breadth and the number of stocks in correction, to stabilize, he explains. "We see this as a relatively normal 're-test' of key technical levels" rather than a fresh round of instability caused — as some observers suggest — by developments in Saudi Arabia or the Italian budget impasse.
"Markets are rotating away from high-growth, high-momentum segments toward more defensive and value-oriented areas that have significantly underperformed in recent times," says Hyzy. "It's part of a broader shift from a low-growth, low-yield, low-volatility environment to a period of higher growth, higher yields and more normal volatility."
Markets are rotating away from high-growth, high-momentum segments toward more defensive and value-oriented areas that have significantly underperformed in recent times."
— Chris Hyzy, Chief Investment Officer for Merrill Lynch and U.S. Trust
As this transition unfolds, investors can expect the portfolio rotation to continue, not just in equities but in fixed income. Capital is moving down the curve as investors move away from high-duration bonds, seeking those with yields rivaling equity dividends. "Because earnings growth and other fundamentals remain strong," says Hyzy, "we believe investor portfolios should focus on long-term equity holdings and bonds with a shorter duration." This approach can create a portfolio "barbell" designed to help protect against large drawdowns, provide potential cash flow, and enable investors to participate in the eventual resumption of the bull‑cycle.
Investing involves risk, including the possible loss of principal.

Past performance is no guarantee of future results.

Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets. Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice versa.
Please read important disclosures below.*
October 12, 2018

A deeper look at recent market volatility

Despite a very difficult period for markets and investors, economic fundamentals remain strong and there's little reason to believe the long bull market in stocks is over, says Chief Investment Officer Chris Hyzy. With a couple of days' perspective (and with markets showing some signs of recovery), Hyzy offers an in-depth look at what's really driving the volatility.
In an "Investment Insights" from the Chief Investment Office, "Eyes Wide Open — Maintaining a Longer Term Perspective," he cites a combination of forces, led by concerns that higher interest rates might lead to slower economic growth. At a time when U.S. technology and growth stocks, in particular, have outpaced other parts of the market, many investors have rushed to sell equities to reduce risk in their portfolios. Technical selling — or selling triggered when markets reach certain levels — caused some domino effects.
While it's important to monitor these continuing developments, stocks are still expected to outperform bonds over the long term.
What investors can do:
Although future equity returns may be lower than they have been recently, once the volatility subsides, you might consider using the market's downturn to add to your portfolio at attractive prices, Hyzy says. While it's important to monitor these continuing developments, stocks are still expected to outperform bonds over the long term.
Read the CIO team's "Eyes Wide Open — Maintaining a Longer Term Perspective" for more insights into the events of the past week and what's ahead for the markets and investors.
Investing involves risk, including the possible loss of principal.

Past performance is no guarantee of future results.

Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets. Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice versa.
Please read important disclosures below.*
October 11, 2018

The latest volatility: What you need to know

So, what just happened?
Wednesday, the Dow fell 831 points and the S&P 500 declined for the fifth day in a row, the first time that has happened since November 2016. The Nasdaq, after leading the market the past few years, is having its worst month since January 2016.
This volatility represents a sharp rotation away from high-growth, high-momentum, highly valued parts of the market and toward cash, fixed-income and defensive equity sectors.
U.S. equities have outperformed the rest of the world recently, and technology and high-growth stocks have outperformed other sectors. "These imbalances had become too large and needed some correction. This is healthy."
— Chris Hyzy, Chief Investment Officer
Here's our take on what this means
"All of this has led to fears that the extended bull market may be at an end. We believe those fears, while understandable, are misplaced," says Chief Investment Officer Chris Hyzy. "As unsettling as they seem, market sell-offs are not abnormal. In fact, typical years include multiple drawdowns of 5% or more." U.S. equities have outperformed the rest of the world recently, and technology and high-growth stocks have outperformed other sectors. "These imbalances had become too large and needed some correction," notes Hyzy. "This is healthy."
"We believe this latest market volatility is being driven by four primary factors," says Hyzy. "First is concern over a continued rise in interest rates. For example, 2-year Treasury yields hit 2.88%, the highest level since 2008. Second is oil prices heading sharply higher, possibly toward $100 per barrel. Third is slowing U.S. earnings growth. And, fourth, is concern over the ongoing trade skirmish with China and fears of a trade 'Cold War.'"
Each has contributed to the recent market weakness. "That said, we feel it is too early to call an end to the extended bull market," says Hyzy. "U.S. economic growth remains strong relative to the rest of the world and in our opinion will not slow down to the extent that some observers predict."
What should investors do right now?
"Episodes of market weakness such as we've seen recently should be viewed as opportunities to consider increasing exposure to high-quality stocks while rebalancing overall portfolios," says Hyzy. "We recommend broad diversification to help protect against sharp drops in concentrated parts of the market, whether particular regions, market capitalizations, styles or sectors. That's why our equity allocations are highly diversified."
"We expect the next few years of this bull market to produce annual equity returns of about 6% or 7% – down from the almost 15% annual gains since 2009, but not yet signaling the end of a decade of rising markets," says Hyzy.
For more insights, read "A Sharp Rotational Pull – But Not the End, the latest Investment Insights from the Chief Investment Office."
All sector recommendations must be considered in the context of an individual investor's goals, time horizon and risk tolerance. Not all recommendations will be suitable for all investors.

Investments focused in a certain industry may pose additional risks due to lack of diversification, industry volatility, economic turmoil, susceptibility to economic, political or regulatory risks and other sector concentration risks.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.
Please read important disclosures below.*
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Asset allocation, diversification, dollar cost averaging and rebalancing do not ensure a profit or protect against loss in declining markets.

Investing involves risk, including the possible loss of principal. No investment program is risk-free, and a systematic investing plan does not ensure a profit or protect against a loss in declining markets. Any investment plan should be subject to periodic review for changes in your individual circumstances, including changes in market conditions and your financial ability to continue purchases.

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Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice versa. Income from investing in municipal bonds is generally exempt from Federal and state taxes for residents of the issuing state. While the interest income is tax-exempt, any capital gains distributed are taxable to the investor. Income for some investors may be subject to the Federal Alternative Minimum Tax (AMT).

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The investments discussed have varying degrees of risk. Some of the risks involved with equities include the possibility that the value of the stocks may fluctuate in response to events specific to the companies or markets, as well as economic, political or social events in the U.S. or abroad. Bonds are subject to interest rate, inflation and credit risks. Investments in high-yield bonds may be subject to greater market fluctuations and risk of loss of income and principal than securities in higher rated categories. Investments in foreign securities involve special risks, including foreign currency risk and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are magnified for investments made in emerging markets. Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates, and risk related to renting properties, such as rental defaults. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Income from investing in municipal bonds is generally exempt from federal and state taxes for residents of the issuing state. While the interest income is tax exempt, any capital gains distributed are taxable to the investor. Income for some investors may be subject to the federal alternative minimum tax (AMT).

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