As of 2/21/2018
- For the first time in two years, the stock market experienced a correction of more than 10%, which included two record-setting drops of over 1,000 points in a single day
- Stronger wage gains in January sparked concerns of rising interest rates and inflation in February
- These concerns have contributed to a spike in volatility, causing stock prices to see more ups and downs over recent weeks
- While markets have been turbulent, economic and corporate conditions point to a positive backdrop for stocks this year
- Stock prices may resume their climb higher — since March 2009, the S&P 500 has declined 10% or more nine times but then rebounded to higher levels
- Nevertheless, investors should expect more turbulence ahead
Data Source: FactSet
Market Update: Are markets headed for more volatility?
Stock market corrections are normal and healthy in the long run
Investors received a wake-up call this month. Sanguine and complacent market conditions over the last 12-18 months finally broke, jarring asset prices from their seemingly unending upward trajectory. Although expectations for continued earnings growth among S&P 500 companies justifies a more optimistic view today, elevated stock valuations and what are now perceived to have been overly optimistic expectations finally caused investors to hit the pause button.
With the Dow Jones Industrial Average and S&P 500 Index off their highs, investors are likely doing a little soul-searching.
Some investors may be questioning the outlook for stock prices following a nearly nine-year bull market run. Over recent weeks, the market has provided the first real test of investors’ will in almost two years.
A change that is not out of the ordinary
The S&P 500 Index fell into correction territory in early February, defined as a decline of 10% or more from its peak level. On average, 10% corrections usually occur once a year. The last time a market correction occurred was early in 2016. Further, a 15% pullback happens, on average, once every two years, with the last occurring in August 2011. However, since stocks reached correction territory they have quickly clawed back some of their losses. More attractive valuations and still favorable growth expectations have allowed investors an opportunity to put cash to work at cheaper prices.
Are you a bull or bear?
To help provide some perspective on the current market environment, we outline both the bull and bear market cases for investors.
The bull argument for further upside in stock prices points to the following:
- Continued synchronized economic growth worldwide
- Expectations for double-digit earnings growth for U.S. companies in the 4th quarter of 2017 as well as for full-year 2018
- Potential near-term fuel from the resumption of corporate buyback activity following a quiet period during earnings season
- Added tailwinds from the recently-reduced U.S. corporate tax rate
- A possible boost from additional U.S. fiscal spending and a potential infrastructure bill
- Little expectation of negative events across other asset categories that could carry over to the stock market (e.g., generally stable conditions in high yield credit markets)
- An absence of recession indicator warning signs, which typically signal an end to a bull market
Nevertheless, the bear case for stocks argues the following:
- Systemic risks from the use of obscure trading and leverage strategies by institutional investors that may be contributing to the market’s volatility
- Rising bond yields, which over time can attract investment dollars at the expense of riskier assets like stocks
- Rising inflation pressures, which could slow economic growth and reduce corporate profitability
- Deficit concerns, fueled by the combination of fiscal spending and tax cuts, which boost short-term growth but potentially result in longer-term economic issues
- Global central bankers ending their ultra-loose money policies, which provided a strong tailwind for asset prices following the financial crisis
Choosing your investment approach
In our opinion, both the bull and bear arguments are valid and illustrate the risk and opportunity in the market today. The truth lies somewhere in the middle, which we believe calls for a prudent and diversified portfolio approach.
Like similar periods in the past, market turbulence eventually passes. After the dust clears, investors can more prudently reassess and evaluate their next moves.
Market volatility may continue in the short term, causing stock prices to ebb and flow. However, global growth is expected to accelerate in 2018, at the same time the trajectory for corporate earnings growth is elevating. These are strong fundamental drives that could ultimately lead to higher stock prices over the intermediate-term.
Following the principles of diversification means you don’t have to decide whether you are a bull or a bear. Rather you only have to determine if you’re an investor and are willing to maintain discipline during times when volatile markets make it more difficult to do so. During times of volatility and market uncertainty, it’s important to discuss your investment strategy with your advisor. They can help you evaluate current conditions and advise you on next steps based on the context of your long-term financial goals.
Like similar periods in the past, market turbulence eventually passes. After the dust clears, investors can work with their advisor to more prudently reassess and evaluate their next moves.
As of February 21, 2018
Data source: Morningstar Direct