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Worried about volatility? Focus on quality

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Calvert disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Calvert are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Calvert fund. References to individual companies for Engagement or Research purposes are provided for illustrative purposes only and may not be representative of the results of all of Calvert’s engagement efforts. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By Joe Hudepohl, CFA, Portfolio Manager, Atlanta Capital and Peggy Taylor, CFA, Investment Specialist, Atlanta Capital

      Atlanta - U.S. equity markets recently marked the 10-year anniversary of the financial crisis bottom. Over this period, the Federal Reserve's profoundly accommodative policies have helped to propel domestic equities higher.

      Simultaneously, market volatility has been largely subdued, hovering near historic lows over much of this time. In other words, stocks generally moved higher in a herd-like fashion, as investors were seemingly focused on simply getting in on the rising markets with little regard for the fundamentals of the underlying stocks.

      The rising tide, it is said, lifts all boats. But is the tide turning?

      Volatility reared its ugly head at the end of last year as investor concerns rose over higher interest rates, slowing global growth and escalating trade tensions. As a result, the S&P 500 Index posted its first negative annual return in 10 years. The fourth quarter's significant decline of 13.5% sunk the calendar year's return to a loss of 4.4%.

      We believe the decline was a healthy reminder that being selective and differentiating between higher- and lower-quality companies may be beneficial when volatility rises. For example, during the fourth quarter, higher-quality companies within the S&P 500 Index lost 12.3%, compared with a loss of 15.7% for lower-quality companies.1

      Higher-quality companies typically have consistent earnings, strong balance sheets, significant free cash flow generation, growing revenues and meaningful competitive advantages.

      Over the past 40 years, there have been only six quarters with larger declines in the S&P 500 Index than the fourth quarter of 2018. In each one of those quarters, higher-quality stocks helped mitigate the downside by outperforming lower-quality stocks by an average of 4.4%.1

      We believe focusing on higher-quality companies makes sense over full market cycles. However, higher-quality companies may really prove their mettle in late cycle environments, and/or when volatility is on the rise. We believe an attractive strategy for equities during market turbulence is to invest in companies with a proven multiyear record of earnings growth and stability.

      Bottom line: Recent events remind us that equities can be a volatile asset class. Should the market continue to be volatile or decline, the impact on asset prices may prove dramatic. Higher-quality businesses delivering more predictable earnings results have natural appeal in most market environments, but we believe they merit particular attention in times of greater uncertainty.