Market Volatility...What Does it Mean?

MARKET VOLATILITY…WHAT DOES IT MEAN?

Yesterday continued a roller coaster week in the global equity markets. The S&P 500 index alone fell 3.75%. This comes after falling 4% this past Monday, only to turn around and increase by nearly 2% on Tuesday. This doesn’t even take into account the significant intra-day swings that have been taking place. In times of market volatility such as these, many clients ask us “what is going on?” The short answer is…likely, several things.

As mentioned in our previous market commentary, the interest rate yield on 10-year treasury bonds continues to rise, indicating that the market is reacting to strong wage data coming from the U.S. Bureau of Labor Statistics with concerns about inflationary pressures. This, in turn, has stoked a belief among some investors that the Federal Reserve Board may move to increase the fed funds borrowing rate more aggressively than anticipated. Such an increase in rates drives up the cost of borrowing for companies, making capital more expensive to come by. This leads to the underlying concern that such an increase in the cost of obtaining capital could have a negative effect on earnings moving forward. Our view is that these concerns may be overstated. ¹
In the past week, the Dow Jones Industrial Average twice has seen drops of over 1,000 points in a single day. Seeing a number of that size can stoke fear and panic in the minds of many lay investors. This can lead to panic selling as some people view the market as a game of musical chairs and don’t want to be “left without a chair when the music stops,” so to speak. Their fears incite worry in them that the market could “go to zero” and they could “lose everything.” So they panic sell, further exacerbating the market volatility. The market is made up of many millions of people, all with their own emotions and fears. Unfortunately, many people react to those fears without sober reflection upon market fundamentals and without remembering to focus on the long term.
In times of market volatility, many computerized trading algorithms are triggered as they seize upon market volatility to make money, essentially upon the fears of other investors that panic sell. ² While such a prospect itself may incite fear among some who read this, it’s important to remember that such computerized algorithms work only to expose near-term market swings due to panic selling. They do not work against those who calmly remain invested and focused on the long-term because there is nothing for them to exploit in such a situation. Eventually, logic reasserts itself over fear and the focus returns to market fundamentals over the long term, as more and more investors identify value and the buyers again outnumber the sellers.
As mentioned in our previous market commentary, a market pullback and/or correction has been possible (to put it mildly) for some time now. Nobody knew exactly when it would happen, only that it was likely to eventually happen. The bull market had been on an unprecedented run recently, with an unheard of 448 days passing without a 3% pullback in the market. This had never happened in the history of the S&P 500 before now. ³ Our observation is that the correction that we’re seeing is healthy, and has been due for some time. To us, this is an indication that the markets are working properly, taking time to digest the extended period of market gains. Corporate earnings continue to be strong, and the economic data being published is indicative of productivity gains rather than inflation. ⁴

The S&P 500 index is off 10.2% from its all-time high on January 26, 2018. ⁵ This is considered “correction” territory in investing parlance. In the post-WWII era, there have been 55 corrections, averaging one about every 16-17 months. ⁶ So, this is normal market behavior. Some might say, “well that’s all well and good but when will the correction end?” And there’s the rub…nobody knows the answer to that question for certain. Historically, some have lasted for a mere 3 days while others have lasted for over a year.

Our encouragement to clients is that each client’s asset allocation plan has been carefully constructed with the long-term in mind, taking into account the inevitable market corrections that occur over time. Panicked selling often leads to missing out when the market rebounds, as history demonstrates that it eventually does. ⁷

As always, please feel free to contact us with any questions. Have a great Friday!

David B. Kearns
Clayton S. Johnson
Dori Riddle
Lauren J. Cantwell