Market Commentary: Market Volatility is Back
Written February 16, 2018
What a difference a month makes. Just last month, I talked about the S&P 500’s parabolic rise in January: “Complacency has turned into a chase for returns. It is unsustainable. It increases the probability of a steeper correction in the coming months. Now don’t get me wrong - you cannot try to time corrections like these, and we strongly urge against it. There is a risk that once a real 10%+ correction occurs, panic selling by blindsided, unprepared investors could make that correction sharper than it would have been otherwise. This could also make corrections more frequent until the extreme volatility feeds into the next bear market.” - January 19, 2018, Market Commentary
I provided this graph of 2006-2008 to demonstrate how low periods of volatility can turn ugly pretty fast. Today I am not so much reminded of 2007, instead I’m thinking more of 2015.
You might recall the S&P 500 fell 11% in five days back in August 2015. That would be today’s equivalent of the Dow Jones Industrial Average falling over 2,900 points in one week. Less than three months later, the S&P was back to pre-pullback levels. After some sideways movement, the market did a retest of those lows in early 2016. Market pundits were pulling their hair out. The market then swiftly fell 13%. However, those who panicked and sold out of the market during that pullback would have felt good about their decision for a month or so before the market recovered over the next two months.
Take a good look at the graph I’ve provided. If an investor sold his stocks in January 2016, when would he have jumped back into the market? The last part of January looked promising, but the market fell even lower the next month. Following that February low were three skyrocketing days in which the market gained back 5%. Should he jump back into stocks after that? It is impossible to know without the gift of hindsight. This is the problem with timing the market – it is based on luck, not skill. This is the reason why we are so adamant about not trying to time pullbacks when we do not see risks of a recession.
Let’s look at where the market stands as I write this on February 16th.
After a stellar 2017, and an incredible January 2018, the S&P 500 gave up all gains (and then some) with a correction of 10% over a two week period. What made that correction look so ugly was the lack of volatility leading up to it. Since that low the S&P has bounced back quickly, regaining half of what it had lost, but we are not out of the woods yet.
What caused this correction was a mix of things, but the catalyst appears to be interest rates. Since former Chair of the Federal Reserve Janet Yellen has left and Jay Powell was sworn in as the new Chair, markets are anxious to see how aggressive he will be in pushing to raise rates. The ten year Treasury yield has risen pretty quickly to 2.90%, a level we have not seen since 2014. Investors are scared interest rates rising too far too fast will put the skids on the economic recovery. But how high is too high?
According to FactSet, it is 5%. If rates are below 5%, stocks tend to rise along with rates. As I write this, we are at 2.90%, nowhere near 5% yet. In my opinion, this is a normal correction in the midst of a still rising market and not the beginning of a bear market. It will probably retest those lows and might even go lower. However, it is a pullback for which we are probably overdue.
If you have been reading my commentaries, you should not be surprised. Remember what I said last month? “I am telling you this for a few reasons. One is a reality check. The low volatility we have seen in the market is not typical, and we should not expect it to continue. Another is to urge you to stay in your proper risk tolerance and not chase returns. Finally, it is to prepare you for what could lie ahead. While no one knows for sure, I would not be surprised to see a sharp, fast drop (or more than one) in the stock market in the coming months. I do not want you to be surprised, either.”
As I have said in previous commentaries, if we are not in a recessionary environment, pullbacks are not to be timed. They tend to last three to six months; they are sharp, and sometimes severe, but usually short-lived. Like earthquakes, pullbacks can happen suddenly, and by the time you know it is happening, there isn’t a lot you can do besides run to the nearest door jam or dive under a sturdy desk. Unlike buildings and roads demolished by natural disasters, the stock market can build itself back up pretty quickly. Most people are investors, not day-traders. The lesson is not to panic. This can lead to rash and often detrimental decisions. Stay the course. Remind yourself this is a blink of an eye relative to the decades you will be investing. Read a good book with a hot cup of coffee – or mug of hot chocolate. Whatever you do, resist the temptation to check your portfolio every fifteen minutes. Even though popular media outlets cover the stock market like it’s the Super Bowl, it is not that exciting. You pay us to worry for you, and we want to help.
This is what I have been training and preparing you for, dear reader. We will keep a close eye on this pullback as it unfolds.
Disclaimers and Notes
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