The last several days have reminded all investors that volatility is part of long-term investing. With the S&P 500 down nearly 10% from its peak over the past ten trading days, many have been quickly reminded that markets do not continually increase. The most recent 10% market pullback was the beginning of 2016; for that and many other reasons, we were likely due. Pullbacks are a necessary part of healthy markets because they can help rid complacency, re-establish both bull and bear market outlook cases, remind individual investors of their true risk tolerance, and force them to review their allocations versus the timelines on their invested capital. Is it fun? Absolutely not. Is it required of markets? Absolutely!
Recently, we heard a metaphor that seems to fit well amid the current volatility. Market pullbacks are like disciplining a child. Neither the child, nor the parent enjoys the process; however, the goal is that the result creates an improvement in the future. For markets to be open and free, we must continue to have market runs and market pullbacks – we must also continue to have believers and doubters.
With that in mind, in our office, we are going through the data to better understand the root cause of the acute volatility. We believe the recent market volatility may be due to one or more of the following reasons (not in order of importance):
- Markets have become a bit complacent and valuations have become lofty. After going on a prolonged positive run, many sectors have traded above long-term average valuations for several months and, in some cases, years.
- We have a new Fed Chair. Although Jerome Powell is not a major cause for concern among market watchers, a change at the helm of the Fed (particularly when there are other market anxieties at play) could be an exacerbating factor. There is an expectation that the Fed would raise rates a few times in calendar year 2018. Janet Yellen was known as a rather “dovish” Fed chairperson, always relying on strong, current economic data and market behavior before initiating a rate hike. It is possible the market believes that Powell may not have quite the same concern for market impact of rate hikes. Regardless, a change brings more uncertainty.
- It’s about time. As mentioned above, we have not experienced a 10% selloff in the markets in two years.
- Interest rates are slightly higher. Market valuations have been generally accepted as high but justifiable due to rates being so low. If rates move higher, this justification erodes quickly.
- Inflation may be appearing soon. Although we have seen few signs of real inflation of late, there is a growing concern that inflation could be moving higher. The very presence of this expectation can have a positive inflationary effect. Although stock market investments are traditionally good long-term in combating inflation, higher inflation data (likely paired with higher interest rates) could be a major headwind for markets in the short run.
- Technical trading adds fuel to the fire. With the proliferation of various automated trading strategies, some people believed that any slight pullback with higher volatility would trigger an onslaught of selling pressure. Late afternoon market behavior where down days have accelerated could be a sign of this.
- Index funds and ETFs are chaining the market together. As ETFs, index funds, and other passive investment strategies have become more widely recommended and utilized, buys and sales of securities have a broader base impact on market behavior. When you sell an ETF, you are effectively selling all the securities in that ETF. In this selloff, although there is some asset class separation in performance, most sectors have sold off together.
For any investor, days like these can be understandably anxiety ridden. We understand. However, we have been expecting volatility and a selloff for some time. This expectation is not a predictive one based on any current market condition. Rather, it is based on market history; corrections are a necessary part of markets and always will be.
Market corrections present opportunities for investor self-reflection. Does your allocation pair your ability to handle risk? Nobody enjoys a seeing the value of their portfolio decline, but are you comfortable with the decline while believing in the long-term opportunities? Is your near-term money protected? Can you separate emotion from investing?
If you or anyone you know is concerned about the recent market volatility, concerned about the answer to these questions, or wants to discuss their current investments, we encourage you to call Ballast at 859-226-0625.