News & Insights
Although easier said than done, investors should do their best to remain objective and unemotional during times of market volatility. We believe that making significant changes in response to short-term market fluctuations is typically not advisable. At the time of writing, U.S. equity markets have essentially “given back” January’s rapid gains, and are now slightly negative for 2018. Below, we offer a brief summary of what has occurred, what the current environment tells us, and what could be next.
U.S. equity and bond markets have led a global selloff in risk assets and government bonds. These losses, combined with an unprecedented surge in volatility, have created a dramatic start to February. Investors may have been caught “off-guard” following a strong start to the year, as well as record-low volatility in 2017. Market declines rarely have a specific reason or rationale, but a few key data points likely caused investors to be cautious:
- Interest rates: From January 1– February 2, yields on the U.S. 10-year Treasury bond rose from 2.40% to 2.84%. Rising rates can have a significant impact on all capital markets (especially in the short term), as well as borrowing costs.
- Markets were over-extended: Equity markets accelerated significantly during the end of 2017 and beginning of 2018. The gains over the last 50 days (as of 1/26, the recent high) was in the top 4% of all 50-day periods over the last 10 years. Further, the S&P 500’s pace of increase in January was akin to nearly a 100% annualized return (i.e., extreme conditions).
- Valuation: Equity markets have been expensive relative to history for multiple years. Investors have accepted the inflated valuations due to low rates and expectations of future growth, but, historically speaking, valuation is critical to long-term performance.
- Business cycle: The recent change to fiscal policy and economic data does not appear to be negatively affecting growth, but the duration of the economic expansion has potentially provided investors with some reason for caution.
Environment & Context
In evaluating market declines, corrections, and even bear markets, investors must critically evaluate both the business cycle and capital market environment to understand the factors driving markets and what related actions may be warranted.
When evaluating the current business cycle, as well as the market environment before and during the sharp decline, we view the current decline as a “market event.” A “market event,” in our opinion, is a rerating of assets or asset classes, but is not driven by broader economic conditions; this is an important distinction, as market events can produce brief corrections or shallow bear markets, whereas market declines in the wake of worsening economic conditions may lead to the more substantial and destructive bear markets that investors fear.
The U.S. economy continues to grow, with many indicators and metrics showing a positive growth environment. Multiple leading economic indicators are growing year-over-year (YoY) and are at levels typically associated with strong economic growth. Additionally, the recently enacted tax cuts are expected to improve economic growth in the near term. The initial steps of this growth improvement have been observed, with many companies paying employees one-time bonuses or making plans for more capital expenditures. Corporate profits are improving, as indicated by companies in the S&P 500 growing their earnings at 13.4% (YoY) and all eleven Global Industry Classification Standard (GICS) sectors reporting positive earnings growth for the quarter.
It is also important to evaluate the market environment, as capital markets are forward-looking discounting mechanisms. Historically, prior to bear markets, astute market observers have noticed deterioration of the business cycle and therefore adjusted portfolios. While we do not subscribe specifically to the notion of “market timing,” these changes in positioning result in subtle variations within market data that can be used as guideposts for market declines. In our view, we believe the trend of the stock market, the spread between treasuries and high-yield bonds (aka “HY spread”), and the CBOE Volatility Index (VIX) are measures that typically provide clues to a bear market. In looking at these trusted indicators, we do not see a highly-stressed market. In fact, when evaluating past occurrences of market declines that were not accompanied by a weakening economy, empirical data shows that markets (and investors taking a long-term approach) have benefited over the following 3, 6, and 12-month periods.
In periods of extreme optimism or pessimism, we like to remember the quote, “history doesn’t repeat, but it tends to rhyme.” We do not expect the “average” return from the above table to be the return profile going forward; BUT, if market conditions can remain relatively intact during this volatility surge and economic conditions remain resilient, we would expect this market shock to pass and eventually be a long-term positive for risk assets, as it reduces some of excesses that warranted caution.
We end this note as we started it – we believe investors should stay objective and unemotional, remaining focused on long-term goals and ignoring the short-term fluctuations within the market. We will continue to monitor market conditions and will proactively provide additional updates as needed. We expect that this will soon be a distant memory on the road to (still) higher equity markets, just like the 2010 China Scares, 2011/2012 Eurozone Debt Crises, 2013 Taper Tantrum, 2014 Ebola Scare, 2015 Flash Crash, 2016 Jan/Feb Panic, etc. (most of which were more severe than the current selloff).
Thank you for your continued trust in us.
Source for all data: Bloomberg
GIS is a team of investment professionals registered with HighTower Securities, LLC, member FINRA, MSRB & HighTower Advisors, LLC a registered investment advisor with the SEC. All securities are offered through HighTower Securities, LLC and advisory services are offered through HighTower Advisors, LLC.
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HighTower Advisors is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.
This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.
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This document was created for informational purposes only; the opinions expressed are solely those of the team and do not represent those of HighTower Advisors, LLC, or any of its affiliates.