Declining UK Interest Rates Tend to Signal  Positive Relative Performance for Low Volatility

We looked at the path of interest rates since 1997 and identified periods of increasing and decreasing rates based on BOE’s action regarding the Bank Rate, as shown in Exhibit 2.

How have low volatility stocks behaved in recent declining rate environments?

Exhibit 3 below compares the rolling 24-month performance for the lowest-volatility quintiles (“Q1 + Q2”) to the highest volatility quintiles (“Q4 + Q5”) of stocks within the MSCI ACWI, and it demonstrates the tendency, since 1998, of lower-volatility stocks to outperform as rates decline (darker shaded periods). 

Exhibit 4 shows us that despite the relative strength of low-volatility stocks during 2022, high volatility has sharply outperformed since the second half of 2021.

Why has lower volatility historically outperformed during declining rate environments?

Cyclical sectors such as retailing, autos, housing and materials tend to experience relative weakness after rates reach their cyclical peaks and economic growth slows. A historical comparison of rolling 24-month performance suggests that companies with more cyclical exposure tend to underperform during periods of declining rates (darker shaded). The chart shows that this was the case during 1998 to 2003, 2008 to 2009, and 2020. During periods of rising rates from 2004 to 2023, cyclical sectors outperformed defensives. 

Conclusion

Our analysis was conducted to address how low-volatility stocks may perform considering the market consensus rate assumptions, which currently anticipate rates cuts, and a declining rate environment for 2024. In this environment, recent cycles suggest that low-volatility stocks have typically outperformed higher-volatility stocks and going forward may provide diversification to portfolios with exposure to higher-volatility and cyclical stocks.

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