So Volatility Is Back – What’s Next?

March 5, 2018

Wow, what a February! Following the peaceful performance of the prior 15 months, market craziness (called volatility) returned to our investment lives last month. Sweaty palmed traders and news commentators seemed hell bent on scaring investors to death. Last month finally ushered into our world the sell-off that had been much discussed. The pundits who appeared to have been “crying wolf” finally  got it right.

To be clear, though, February was not an anomaly for the market. It was merely a return to the norm. Over the last 80 years there has been an average of three pull backs in the market each year of 5% or more. There is, on average, a 10% correction in the market every year, and a 15% correction every two years. We have not had a 15% pull back since 2011.  The multiple market moves of hundreds of points in February looked frightening in the headlines, but remember a 240 point move is only a 1%  change when the market is at 24,000. Last month was really just a return to business as usual.

So given we are back in a normal market where volatility is to be expected, what major drivers should investors focus on during this bumpy trip. Below are six observations:

1.  The quality of earnings of companies does matter.
2.  When the economy is doing well, the Fed will tend to raise rates.
3.  When consumers feel some security in their job, they spend money.
4.  Corporate tax cuts will have multi-year benefits to companies and shareholders.
5.  What is happening in Washington DC probably matters more in the short run than in the  long run.
6.  Short-term rates are going up. Savers will be happy and stock investors will worry.

The market is considering the likely behavior of investors as rates rise. We have seen short term rates go up by 75 basis points this past year, and a further rise 75 basis points is predicted for the rest of the year. We are getting close to a time this year when investors can earn a return of 2% on treasury bills. This might cause some equity investors to question their long-term commitment to owning stocks.  It strikes me that the singular biggest risk to the current market is the way investors will adjust to higher rates. The fundamentals would suggest that, from an earning perspective, there should be little to worry about, but all markets are driven to a great extent by emotion, and especially by worry.

The person responsible for orchestrating this return to higher interest rates is the new head of the Federal Reserve, Jerome Powell. The last two Fed Chairpersons proved to be very adept at conducting the orchestra of the market through uncertain times. Time will tell if the new maestro will be able to wield his baton with the same positive outcome.

Carl Gambrell