If you’ve been watching the markets since the beginning of the year, you know the roller coaster we’ve been on. If you haven’t been, then please disregard this blog. Just kidding, don’t do that. Here’s a recap: the S&P 500 posted a dividend reinvested return of 21.83% for the full year 2017. Assuming you bought the index at the closing price on December 30, 2016 and sold at the closing price on December 29, 2017. January 2018 saw that momentum continue, with the S&P 500 advancing 7.4% by January 26th. Then a massive pullback happened with the S&P500 losing 10.1% over the next nine trading days. Since then, we’ve recovered about ½ of that loss and are now positive for 2018 (as of 2/23/2018). So, what’s going on?
Well, a lot actually. There were/are many forces at work in the market, but here’s my take. Over the last several years, we’ve been in an environment of slow economic growth and low inflation. Interest rates across the board have been very low, both domestically and overseas. And, throughout 2017, the stock market has been on the rise with volatility (as measured by the VIX) almost non-existent. Enter 2018.
The ten year US Treasury yield starts to rise. This was largely the result of higher anticipated growth, leading to higher inflation, the Fed raising rates, and the Fed reducing its balance sheet (i.e. not buying as many bonds). In the first month of the year, the ten year yield rose from 2.405% to 2.72%. Then on February 2nd, the Employment Situation report from the Bureau of Labor Statistics showed wage inflation of 2.9%, the highest it’s been in almost nine years. This caused the ten year Treasury to spike to a 2.85% that day.
The stock market’s subsequent fall was initially the result of the rise in wage inflation and interest rates. Although we’ve been waiting for wage inflation for a while, the 2.9% read seemed to scare investors. The fear is that this is a sign of more inflation than anticipated and that the Fed could raise interest rates more aggressively than originally thought. This could lead to even higher interest rates. All things being equal, higher interest rates reduce the valuation of stocks. Think of it this way: assume an investment is paying 8% and the US Treasury rate is at 2%. This means the investment gives you 6% of additional return. If the US Treasury rate went to 4%, you would probably be willing to pay less for the investment because the additional return is less (now only 4%). (Please note this is just an illustration and not an actual investment)
This initial move caused more mechanical problems, however. As the stocks went down, the volatility index (VIX) went up. The VIX, which had spent most of last year between nine and 15, spiked to almost 40 during the week of February 5th. This caused many large institutional trading programs which use the VIX as a way to control downside losses to sell automatically. As an example, programs that trigger when the VIX hits 25 will sell, and cause markets to go down which makes the VIX go even higher. This will trigger programs that target the VIX at 26, which causes more selling, and so on and so on. These programs are suspected of causing the extreme volatility when the Dow Jones Industrial Average dropped 776 points in nine minutes on February 5th, on its way to a one day drop of 1,175.
So, was this the correction we’ve all been waiting for? Well, maybe. Technically, we did drop by 10% or more. So yes…? However, we’ve already recovered about ½ of that, which means valuations are significantly the same as they were before the “correction”. On average, a correction will last three or four months*. So far it’s been two weeks.
Going forward, I believe we will continue to see very choppy, volatile markets as investors try to re-value where they believe the market should be. Many questions still remain: where will interest rates go? How high will inflation be? Will GDP increase faster due to tax reform? Among many others. There is also a disconnect between the stock market and the economy. This is not necessarily unusual, but exacerbated by heightened uncertainty. The higher wage inflation should be a good thing, indicating that the corporations are doing well and hiring, the labor force is earning more and the economy is growing. But, stock valuations may need to adjust due to higher inflation and interest rates. Somewhere in there is equilibrium. In theory, anyway.
Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (“CFS”), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. Verity Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.
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An Investment Advisor registered through CUSO Financial Services, L.P., Gavin has 22 years of experience as an advisor in the Puget Sound area.
“I believe every client is unique and deserving of a personalized financial plan that will help them reach their individual financial goals. Before I make any recommendations, I like to get to know my clients. By asking the right questions, and developing an honest, trusting relationship I can really get a sense of what’s going to work best for them.”
Gavin graduated from the University of Washington with a BA in Business Administration and started his financial career with US Bank in the Investment Department. Prior to joining Verity in 2006, he spent eight years with Piper Jaffray.
So what is Gavin’s vision for his dream retirement?
“My dream retirement would be absolutely worry free: financially, emotionally, and in every aspect of life. My finances would be in order so expenses for travel, luxuries, and gifts for the kids, grandkids, and great-grandkids would be taken care of. My kids would be financially sound, so I would be confident in their prosperity. This would give me the freedom to travel and play and do whatever it is I want to do.”
When Gavin’s not working, he enjoys spending time with friends and family, watching Husky football, and taking weekend trips around the Northwest.
Gavin is registered to transact securities business in the states of WA, OR, CA, AZ, FL, HI, ID, IL, MN, NM, NY and VA.
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