This article was written by Invesco PowerShares Senior Equity Product Strategist Nick Kalivas.
May is upon us, and as an old Wall Street adage goes, “Sell in May and go away.” True to form, the investment landscape is as confusing as ever in early May, with evidence of seasonal volatility in the equity markets.
Historically, the S&P 500 Index has posted relatively weak performance from April 30 through Oct. 31. In fact, from April 30, 1992 through Oct. 31, 2014, the S&P 500 Index has returned an average of 2.65% from April 30 through Oct. 31 of each year, compared with an average return of 7.65% from Oct. 31 through April 30 during this same period.1 Investors that have pursued a low volatility strategy, however, have been partially buffered from market weakness. From 1992 through 2014, the lowest volatility quintile of the S&P 500 Index outperformed the overall index by an average of 2.09% from April 30 through Oct. 31. 1
Contributors to market volatility
As we assess the market landscape in May 2015, I believe one risk facing investors is the strong US dollar. In one sense, a rising dollar underscores confidence in the US economy. A robust economy attracts investment from around the globe, but also makes dollar-denominated goods more expensive in foreign markets – weakening demand – while reducing the value of exports purchased in euros, rubles and yen.
Exacerbating the strength of the dollar is a growing disparity in monetary policy between the United States and Europe. While the Federal Reserve is in the early stages of tightening credit, the European Central Bank (ECB) only began quantitative easing in March – a process expected to last through late 2016. Cuts in the ECB’s refinancing rate have resulted in negative deposit rates throughout the eurozone, driving investors to the US credit markets and further distorting exchange rates.
Partially in response to the strong dollar, corporate earnings have come under pressure and the US manufacturing sector is struggling. Non-defense capital goods orders are well below last summer’s peak, and first-quarter GDP reflected a $110 billion gain in inventories, which could hamper economic growth in the second quarter.
Fears of a credit default in Greece and overextended equity markets in China have given investors added reason for concern. A collapse in the Chinese markets or a Greek exit from the eurozone could trigger a flight to quality and lead to global contagion. There is some solace to be found in the ECB’s decision to extend $78 billion in liquidity to Greek banks, but this, too, is likely to depress European interest rates and prop up the dollar, in my view.
Potential implications for investors
As we move into a historically weak period, investors are clearly facing many headwinds. But even with rich valuations, there is still room for price-to-earnings multiple expansion. I believe the macroeconomic conditions outlined above make a compelling case for low volatility investing. Of course, low volatility cannot be guaranteed. After speaking with a financial advisor, investors may want to consider adding low volatility equity strategies to their portfolios, including the PowerShares S&P 500 Low Volatility Portfolio (SPLV). SPLV invests at least 90% of its assets in the lowest realized volatility common stocks of the S&P 500 Index over the past 12 months.
1 Source: Bloomberg L.P., FactSet
A stock’s price-to-earnings multiple (also known as its price-to-earnings ratio) measures its valuation. It divides a stock’s current share price by its earnings per share.
Volatility measures the amount of fluctuation in the price of a security or portfolio. Volatility was measured using standard deviation of returns.