Last week was a quiet week for stocks. As I was writing my new weekly commentary, the S&P 500 rose or fell less than 0.1% for four consecutive days, the longest such stretch in 25 years. The tight trading range could be attributed to countervailing forces of good economic data — namely, strong U.S. retail sales data and a decent gross domestic product report in Europe — balanced against lingering concerns over the conflict in Russia and Ukraine.
Equity market volatility has drifted back toward the low teens (around 13 on the VIX Index), but we believe this relative calm to be a temporary phenomenon. Although seasonal strength may keep volatility below normal for the remainder of the year, the situation is likely to change in 2015. A shift in U.S. monetary policy next year (i.e., Fed action to raise short-term interest rates) could lead to spikes in volatility of the type we witnessed in September and October.
Against this broad backdrop, we drew a few key conclusions.
A more favorable view toward U.S. small-cap stocks. After dramatically underperforming year-to-date, we are starting to see some shift in sentiment. We had been advocating an underweight to U.S. small caps all year, but would now favor a more neutral stance.
Confirming our preference for equities in Japan and China. We continue to see good opportunities in these Asian markets, which have been outperforming of late.
Japanese stocks surged 3% last week to a six-year high (although it surrendered most of those gains on Monday), driven by good earnings, the weakening yen and hopes that an expected tax hike will be delayed. According to local reports, Prime Minister Abe is likely to call a snap election around mid-December and postpone the sales tax increase scheduled for next October.