Takeaways from a turbulent week

The S&P 500 fell 3% last week, marking seven straight weeks of declines for the first time since 2001. A turbulent week also included the biggest one-day fall in the index since 2020 on Wednesday (–4.04%), and a brief dip into bear market territory—a 20.6% fall from its January peak—during Friday's session.

The index has swung by more than 2% in six of the 15 trading days so far in May, and the VIX index of implied volatility indicates that investors expect markets to stay choppy. The index ended the week at 29, well above the long-term average of 19.5 and consistent with daily moves in the S&P 500 of around 1.8%.

We believe markets will remain turbulent until investors get greater clarity on the 3R's—recession, rates, and risk. Over the past week there have been conflicting signals on all three.

US economic data has been encouraging, with retail sales rising 0.9% month-over-month in April and industrial production up 1.1%. But some retail earnings have pointed to emerging weakness, with Target and Walmart both highlighting rising cost pressures.

Federal Reserve Chair Jerome Powell said last week that the central bank “won’t hesitate” to raise policy rates to levels that restrict growth if that is needed to bring down inflation.

Federal Reserve Chair Jerome Powell said last week that the central bank “won’t hesitate” to raise policy rates to levels that restrict growth if that is needed to bring down inflation. The Fed’s hawkish stance appears to be helping keep inflation expectations under control: From a peak of 3.1% a month ago, the 10-year US breakeven inflation rates, a market-based measure of inflation expectations, have fallen to 2.6%. St. Louis Federal Reserve Bank President James Bullard, who still favors pushing policy rates above 3% this year to get inflation under control more quickly, noted that front-loading Fed tightening could enable rates to be lowered next year and in 2024.

China has moved toward phasing out lockdowns in Shanghai, while rising cases in Beijing have raised concerns of curbs in the capital city. The conflict in Ukraine also remains a source of uncertainty.

The recent swings in equity markets show that attempting to time the market in periods of economic and geopolitical uncertainty can be expensive and risky. It is almost impossible to know which trading days will be the worst, and by trying to avoid those days, investors may also miss the recovery.

So, how to position?

In our base case of moderating growth and inflation, we expect equity markets to end the year higher than current levels. Accordingly, we believe that investors should stay calm, stay invested, and consider ways to manage the current volatility:

Consider defensive segments of the equity market.

• Healthcare stocks tend to be less sensitive to economic fluctuations, so investors can mitigate recession risks by positioning in the sector. It is also one of our most preferred sectors in global equities, as it offers an exposure that combines structural growth with defensive characteristics. Valuations in the sector look undemanding, with pharma stocks particularly attractive.
• Select quality stocks—those offering things like attractive dividend yields, free cash flows, and a sustainable return on equity—are also typically steadier during periods of volatility.

Certain hedge fund strategies are well placed to outperform in periods of high volatility.

• This has been the case so far this year, with the HFRI Fund Weighted Composite index down just 2.3% in the year to the end of April, compared with the S&P 500’s 12.9% drop (total return) and an 11.3% retreat in the Bloomberg Aggregate Global Bond index. With a focus on risk management and downside mitigation, hedge funds can be a defensive way to build market exposure or reduce risk. For example, macro hedge funds returned 10.3% during January to April.

Commodities are an effective hedge against geopolitical and inflation risks.

• We see 10% upside in total return for broad commodities over the next six months, and we maintain our preference for energy stocks. With the global commodity market already facing a supply challenge heading into 2022, supply disruptions arising from the Russia-Ukraine war and weather events are likely to keep prices elevated. Over the longer term, tight market fundamentals and the green transition should also be supportive of the asset class.

So, given that trying to time the market can be risky and expensive, we recommend staying invested and using strategies to manage uncertainty and volatility. Beyond defensive equities, hedge funds, and commodities, structured solutions can offer ways to manage the risk of drawdowns while staying invested.

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