The Federal Reserve has vowed to control inflation with higher interest rates. The tightening monetary policy, along with growth uncertainty, are resulting in an extremely volatile market environment. As volatility continues, investors may want to position equity portfolios more defensively.
This article was written with contributions from Vasco Laranjo. Vasco is a Research Analyst on the SPDR Americas Research Team.
The S&P 500® Index fell 4% last week, giving up all its gains for the month of August. Nearly all sectors were down for the week as well; only Energy saw gains, rising 4.3%. The US 10-year Treasury yield closed at 3.04%, finishing the week above 3% for the first time since early July.
Energy Continues to Spike
Gazprom announced that it would shut down the Nord Stream 1 pipeline for three days of unscheduled maintenance. The pipeline, owned by Russia, runs from Russia to Germany via the Baltic Sea. News of the shutdown sent European natural gas prices soaring to all-time highs.1
Multiple Data Reports on the Horizon
On Wednesday, the eurozone will release August’s CPI figures. Annual inflation is expected to accelerate to 9.0%, from 8.9% in July. China’s PMI data for August are due out on Wednesday, too, with the Caixin private sector PMI due to be released the following day. The ISM Manufacturing Index for August should be released on Thursday, with a slight decrease expected compared to last month (52.0 versus 52.8).
On Friday, the market will be watching nonfarm payrolls. This will be the final employment report before the Federal Open Market Committee’s (FOMC) September meeting. Economists expect to see that the economy has added 285,000 jobs in August, and the unemployment rate to be steady at 3.5%.
Fed Vows to Control Inflation
At last week’s Jackson Hole Symposium, Federal Reserve (Fed) Chairman Jerome Powell reiterated that the Fed will continue raising rates — and will hold them at a higher level — until it is confident that inflation is under control. Powell’s comments come as the headline PCE Price Index cooled in July. On a yearly basis, the July reading was 6.3% versus 6.8% in June. On a monthly basis, it fell by -0.1%, the first decline since the onset of the pandemic.2
It’s also notable that as the Fed reiterates its focus on inflation, the University of Michigan Surveys of Consumers for August came in much stronger than expected for Sentiment (58.2 in August versus the expected 55.5), current conditions (58.6 versus 55.6) and expectations (58.0 versus 55.0).3 The August results were also well above July’s survey results.
Volatility Calls for Disciplined Investing
Tightening monetary policy and growth uncertainty continue to create an extremely volatile market environment. The year-to-date (YTD) daily average for both the Chicago Board Options Exchange (CBOE) Volatility Index (VIX) and the ICE BofAML MOVE Index are at least 20% higher than their respective long-term averages.4 And with the approaching 2022 US midterm elections, coupled with a divergence between market expectations and the Fed’s projections for rates next year, volatility is likely to persist at least into Q4 of this year.
In the face of ongoing volatility, investors may want to position portfolios more defensively.
The SPDR® S&P® Dividend ETF (SDY) screens for companies with at least 20 years of consecutive dividend increases. SDY may help investors weather the continued volatility as it has tended to outperform the broad market during periods of elevated volatility, as shown in the chart below.
SDY takes a rigorous approach to dividend investing, which has led to a defensive portfolio of stocks with strong balance sheets and disciplined capital management. SDY has outperformed the S&P 500 Index by 12.7% this year with lower volatility and less drawdown, underscoring its ability to add resilience to a broad equity exposure during a market downturn.5 It has also outperformed the median fund in its Morningstar category by 46% on a cumulative basis over the past ten years, and ranks in the top sixth percentile based on risk-adjusted returns.6
SDY Excess Average Monthly Return Over S&P 500 During Different Volatility Regimes
SDY Standard Performance as of June 30, 2022
1 Bloomberg Finance, L.P., as of August 26, 2022. 2 Bureau of Economic Analysis, as of August 26, 2022. 3 University of Michigan Surveys of Consumers, as of August 26, 2022. www.sca.isr.umich.edu. 4 Bloomberg Finance, L.P. Long-term average period for VIX Index is 1/2/1990 – 8/24/2022. Long-term average period for the ICE BofAML MOVE Index is 4/4/1988 – 8/24/2022. Past performance is not a reliable indicator of future performance. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable. 5 Morningstar, as of August 24, 2022. Past performance is not a reliable indicator of future performance. SDY YTD total return is 0.45%, while the S&P 500 Index is -12.24%. SDY YTD standard deviation based on weekly returns is 2.49%, while S&P 500 is 3.14%. SDY YTD max drawdown is -13.18%, while S&P 500 is -22.99%. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable. 6 Morningstar, as of August 24, 2022. Past performance is not a reliable indicator of future performance. Peer group is based on Morningstar US Fund Large Value category, which includes ETFs and mutual funds (oldest share class). The peer group includes 282 funds. SDY 10-year cumulative return is 225%, while the peer group median is 179%. SDY 10-year annualized Sharpe ratio based on monthly returns is 0.91, while the peer group median is 0.76.
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