Instability Persists - A Permanent Fixture in Sight
In the first quarter of 2018, the global equity market experienced a significant surge in volatility, primarily due to heightened policy uncertainty, particularly surrounding trade tariffs and reciprocal tariff announcements by the U.S. government.
Markets were unsettled by unpredictable trade policy announcements and tariff impositions, which disrupted market confidence and caused sharp swings in stock prices and corporate credit spreads. Investors responded by reducing risky exposures and seeking safer assets, leading to significant market volatility.
Such trade policy shocks led to pronounced moves not only in equity markets but also in other asset classes, influencing currency markets (notably the U.S. dollar) and bond yields, with increased long-term yield volatility reflecting concerns about fiscal sustainability.
The volatility affected multiple investment strategies. Equity markets experienced sharp corrections initially but then rebounded as some tariffs were walked back, creating a “relief rally” dynamic. This environment caused active management to adapt quickly, with a focus on sectors resilient to trade tensions or benefiting from policy shifts, such as technology and industrials.
Investors’ risk management strategies evolved. They reduced currency risk exposure and adjusted duration risk in their fixed income portfolios amid fluctuating yields. The reaction highlighted the importance of diversification, especially globally, as international and emerging markets sometimes outperformed U.S. equities during such episodes.
The period underscored the impact of geopolitical risk, tariff policy unpredictability, and weakening economic data, which led to lowered earnings forecasts for broad equity indices and increased uncertainty around growth prospects.
In summary, the key driver of the Q1 2018 equity market volatility was trade policy uncertainty and tariff announcements that heightened market fears and led investors to rapidly adjust exposure across sectors and asset classes. This environment challenged investment strategies to balance risk reduction with seizing opportunities in resilient or emerging growth areas, such as technology. The episode reaffirmed the value of global diversification and active portfolio management to navigate periods of elevated volatility.
Looking ahead, the U.S. fiscal deficit is expected to evolve into a bigger problem than currently anticipated due to increased spending and reduced government revenue. The prospects for a continued equity bull run seem to have diminished due to factors such as re-rating lower PE multiples, increased regulatory focus on FAANG stocks, and "trade war" rhetoric. Higher short-term interest rates and a reduction in global monetary stimulus are expected to create a headwind for credit markets. Hedged relative value and trading-oriented strategies are expected to outperform directional strategies for the balance of the year. We have entered a higher volatility regime that is causing investors to recognize tighter financial conditions, increased geopolitical uncertainty, expanding deficits, and a U.S. economy in the late stages of expansion.
Institutional investors have been compelled to reconsider their investing strategies in light of the increased volatility in the global equity market, characterized by heightened policy uncertainty and trade tariffs. Meanwhile, these investors have been focusing on reducing risky exposures, diversifying their portfolios, and seeking out sectors resilient to trade tensions, such as technology and industrials.
This evolving investment landscape, driven by unpredictable trade policy announcements and tariff impositions, has further emphasized the importance of active portfolio management and global diversification in finance for businesses to navigate periods of elevated volatility effectively.
