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From our Investment Team | Weekly Commentary 2.5.18

by: Investment Team - Rfg Advisory Group .
published: February, 05th 2018


Investment Team – Weekly Commentary

Volatility returned last week with the market having multiple negative trading days, alarming investors given the smooth path of performance in 2017. At Friday's close, the markets had experienced a globally coordinated sell-off across asset classes with the S&P 500 and STOXX Europe 600 having their worst weeks since January and November 2016, respectively. Additionally, the VIX (which measures expectations for equity price swings for the next month) spiked to levels not seen since November 2016, foreshadowing the potential for future volatility.

For most of the recent bull market, the markets have enjoyed a Goldilocks scenario - a period of growth, low inflation and accommodative monetary policy worldwide. These forces have helped to drive asset prices to record highs as central banks held interest rates low to stimulate their economies, however the recent economic strength globally (as evidenced by the strong US Jobs report on Friday and recent upward revisions in European GDP growth expectations) is causing central banks to reevaluate their outlooks. 

Markets understand that central banks are forward-looking, and primarily concerned with their two policy objectives: stable prices and the level of unemployment. Thus, the coordinate sell-off that we saw last week is in response to the potential for central banks to raise rates even faster than currently communicated to meet their goals. As Rick has previously mentioned, rising rates will effectively act as a brake on economic growth, keeping the economy from overheating. These rising rates also raise the discount rate that long term investors use to value their expected future cash flows – in other words, equity multiples may come down as a result. Prices may continue to correct to reflect these changes in assumptions in stocks, and these adverse price movements across Equities and Bonds last week were challenging for portfolio managers as assets showed a strong correlation. 

All of this said, keep in mind that the underlying driver of the sell-off has been STRONGER growth than expected, which is ironic given that securities prices are falling. Roughly 80% of the S&P500 firms that have reported quarter to date have beaten forecasts, and growth continues to be robust internationally. Generally, sustained bear markets are associated with economic recessions, not the correction we witnessed last week. While we may see some additional volatility in the weeks ahead, our outlook remains generally the same with respect to continued economic strength and rising earnings. Said differently, the Goldilocks scenario of high growth with very low inflation and low interest rates does not appear to be unfolding, but high growth with higher interest rates is not something we are overly concerned about. So long as the global economy does not stumble, this type of valuation driven sell off is likely to be short lived.

 

Rick Wedell is not affiliated with LPL Financial

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Investing involves risk including loss of principal.