Welcome Back, Volatility

February 5, 2018

Do you remember the popular 1970s sitcom Welcome Back, Kotter? It was about a high school teacher who returns to his inner city alma mater to teach a remedial class of slackers known as the “Sweathogs”. The show was originally meant to be simply called Kotter, but the writer of the show’s theme song, John Sebastian of Lovin’ Spoonful, couldn’t come up with a rhyme. Instead, he penned “Welcome Back” which went on to become a No. 1 hit. We were reminded of that song last week as volatility returned to the stock market after a remarkably long absence.

To put this in context, by one measure last year was the least volatile year in the stock market since 1965. There were only eight days in 2017 where the market moved up or down more than one percent, as compared with the annual average since 1930 of sixty. Moreover, this period of low volatility has seen a gradual rise in equity prices with, for example, the S&P 500 being up for 15 months in a row. That has never happened before.

Then last week we ended the longest streak without at least a 3% fall in the market, with a pull back for the S&P 500 of about 3.9% from its most recent high. Things have been so smooth and steady recently that this volatility feels uncomfortable. If we look at the broader context, however, there have actually been an average of seven pull backs of this magnitude per year since the late 1920s. The fall in the Dow of 666 points on Friday was a big decline, but we should remember that it only amounts to a 2.5% drop. Volatility of this sort is quite normal for the stock market and should be expected.

What does this mean for investors? We follow a number of analysts and thinkers to stay abreast of insights into market behavior. Two are worth noting here. The head of the Capital Markets Team at Vanguard recently reiterated his team’s view that while a correction is quite likely in the U.S. stock market this year, a bear market is not on the horizon. As you may recall, a correction is a 10% pullback while a bear market is a 20% pullback.  Bear markets are typically (but not always) associated with recessions and Vanguard sees no recession for at least the next 12 to 18 months.

The other insight worth sharing is from Professor Jeremy Siegel of Wharton Business School, and author of the investment classic “Stocks For The Long Run”. Professor Siegel also sees a meaningful chance of a correction this year, but expects stocks to finish the year in positive territory. He points to strong earnings and continued economic growth as drivers and, like Vanguard, he sees no recession on the horizon.

We will continue to monitor developments as events unfold, while recognizing that more normal levels of volatility seem to have returned. Welcome Back?

Mike Masters