Thoughts on the Market

April 3, 2018

Stock market volatility is back. Last year, it seemed like no headline could shake the extraordinary calm of the market, and the largest peak-to-trough move in the S&P 500 was just 2.8%. As we saw yesterday, this year even minor news can move the market over 3% in just a few hours. What changed?

Let’s start in January. From 12/31/17 to 1/26/18, the S&P 500 Total Return Index rose 7.6%. Then from 1/27/18 to 2/8/18, the S&P 500 Total Return Index fell 10.1%. We described probable reasons for the market correction in our 2/5/18 email to clients – fear of rising inflation and interest rates, an unwind of overly bullish investor sentiment and crowded momentum-based trades – but concluded the following: “We believe the best answer is that just as the equity market rallied strongly with no significant changes in the market narrative, it declined with no significant change in the market narrative.”

From 2/9/18 to 3/9/18, the S&P 500 Total Return Index rose 8.2%. Then from 3/10/18 to yesterday 4/2/18, the S&P 500 Total Return Index fell 7.3%. Sound familiar? For the stock market, volatility often begets more volatility as investors adjust to the new environment, and we are likely in for more ups and downs until market settles into a new range. Here are some probable reasons for the latest decline, all of which are a threat but none of which have had any permanent impact so far:

  1. Trade war fears: While concerns over NAFTA remain, lately trade concerns have centered around the US and China, which are now going tit-for-tat in a tariff battle. It is unclear if these tariffs can be sustained after WTO procedures, but those could take a number of years to conclude. President Trump’s latest action was a relatively vague policy of enacting tariffs on $60B of Chinese imports. China retaliated over the weekend by placing tariffs on US imports of pork and fruit.
  2. Unwind of crowded technology trades: This process accelerated on 3/19/18 with the news that Facebook data may have been utilized for political benefits in an unauthorized manner. Consumer reactions and legislation stemming from this could have a number of implications, including new laws governing data used for digital advertising, who owns these data rights, and whether or not digital companies can use consumer data by default when a consumer uses an app/service. If these items were to change, the earnings power of ad or consumer-data based tech companies may change. Most recently, President Trump has made comments critical of Amazon. The President has argued that the company is taking advantage of the tax system and is unfairly subsidized by the US Postal Service. While the direct impact of these headlines only affects a few companies, these firms’ popularity with short-term traders are causing a broader shift in market sentiment.
  3. The impact of rising inflation on the economy and profits: While global interest rates remain historically low, the worry is that Central Banks will be forced to raise rates more than expected over the course of 2019 and 2020 to counter rising inflation. With global debt levels at or near all-time highs for most governments, consumers and businesses, interest rates can only rise so far without causing widespread repayment issues, especially if economic growth stalls. Rising wage inflation will also have a negative impact on corporate profit margins.

We will end this email similar to the way we ended the 2/5/18 email, as nothing major has changed on this front:

Reasons to remain positive:

  1. Corporate earnings have been strong and will be helped even further by tax reform
  2. Global economic growth trends are still looking very positive
  3. As far as we know, there is no news out that justifies a significant sell-off from today’s market levels

As long-term investors, we do not believe in tactical market timing. We recognize that there is no simple formula to know the future direction of the market, and by recognizing what we don’t know, we can eliminate personal biases from our investing process. We believe that sticking to a properly selected target risk level in both good times and bad is the best recipe for long-term investment success, with higher target risk levels most likely leading to the best long-term returns. The volatility of the past few months actually gives you a good opportunity for a gut check of your emotional risk tolerance. At some point in the future, we believe it is inevitable that the stock market will have a major correction well beyond what has been experienced the past few months. If you do not think you will be able to stay the course during such an event, then we believe your target risk level should be revisited. As always, feel free to contact us with any questions you may have about your unique situation, including the risk level of your portfolio.

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