When will volatility return to the stock market?

February 15, 2018 by Ford Lankford

For the past year many folks have been asking when will volatility return to the stock market?  Well, it appears as if it finally has.  So, I want to share a few thoughts after studying recent headlines, index averages and industry analysis.  Hopefully, this will provide some context on the recent correction.

The numbers:

  1. Today’s retreat lowers the S&P 500 to 2,580 – a drop of just over 10%, officially considered “correction” territory (20% or more would be considered a bear market).
  2. The correction accelerated last Friday morning when the government reported wage inflation of 2.9% over the past year, more than expected.
  3. In 2017, the S&P 500 advanced in every month for the first time in history.
  4. The 10-year U.S. Treasury bond (considered the “risk-free” rate) has gone from a 2.40% yield to 2.85%.  In percentage terms, that’s nearly a 20% advance on fears of both inflation and increased government spending plans.

My thoughts:

  1. Despite the decline, we’ve essentially traded back in time to market levels of 3 months ago (November).  This is roughly when the tax reform package started looking possible.
  2. Tax reform packages typically take time to filter through.  Consumers will wait on refunds and corporations on reductions, so it will likely be a few quarters before improvement could be seen in corporate earnings.
  3. It seems no coincidence the market has flinched during the Janet Yellen to Jerome Powell Fed transition.  Federal Reserve leadership change is always an uncertain event for the market – history has proven it.
  4. Powell is thought to be more aggressive on raising interest rates, but if the market balks at higher rates, then Powell can always stall and raise them later (or slower) than planned.  Not a bad position from which to lead our nation’s monetary policy.

When we look for signs of a bear market, we look for the usual suspects:  commodity spikes; aggressive Federal Reserve policy; economic recession; and extreme valuations.  None of these indicators (except valuations) are present today:  oil isn’t spiking; interest rates remain historically low; the economy is improving; but stock market valuations “should be higher than normal” in this ultra-low interest rate environment.  That said, when looking at the chart of the S&P, there is moderate support at the current 2,580 level; there is greater support at the 2,450 level (this would be around a 14%-15% correction); and then good support again at the 2,350 level (an 18% drawdown).  Any of these scenarios are possible, but this drawdown does feel like a correction long overdue.  Either way, the underlying economy looks strong and we believe this correction will likely run its course and settle into a healthier market foundation that can resume growth going forward.  And as always, for those sitting on available cash, this will likely be seen as an investment opportunity. 

Most importantly, though, should you have any questions about your portfolio or want to review your overall asset allocation, just let me know.  Asset allocation is “always” the most important factor in attaining your portfolio goals over time.