With the market closing negative the past two days the question could be asked, is this a brush fire or a forest fire? I enjoyed the following article outlining how significant or insignificant the past two days have been. Read time is less than five minutes. Enjoy.
Brush Fire or Forest Fire? Thoughts on the recent market volatility
Written by Ladenburg Thalmann Asset Management on 2/5/2018
For the first time in 2 years, the equity market is experiencing a selloff at nearly -5%. For many investors this is sparking concerns about the potential that the nearly 9 year old bull market may be ending. Additionally, bonds are normally a safe haven during equity market selloffs but in this occasion, bonds are also under pressure and are now down for the year. A recap of last week has the Dow down -4.1% and S&P 500 down -3.9% while the 10 year US treasury was also down - 1.4%.
A few things to consider before determining if this is a brushfire that cleans out weeds, or a forest fire that burns an entire forest:
1) Market corrections of 5% are very normal and usually occur 3 times on average per year.
2) Current economic data is good and expected to improve. For example, companies within the S&P 500 are exhibiting earnings growth of 14.81% for Q4 2017 with 256 companies reporting so far and 4th quarter GDP grew at 2.6% and unemployment is down to 4.1%.
3) Inflation continues to be 50% below the historical average at 1.8% and interest rates remain near historical lows even though they are up year to date.
The recent selloff in the equity and bond markets can be directly attributed to the longer term potential of interest rates going much higher. The concern has been that after years of ultra low rates which allowed for extremely low borrowing costs, companies and individuals will begin to pay more to borrow. This would lead to an inflationary cycle with goods and services increasing in price, which is the first sign of the end of a bull market and start of a recession as the economy becomes over heated.
Our view at LTAM is that this a normal market selloff or brush fire, in our earlier analogy. Current economic data is good and improving, tax reform will drive earnings higher and justify recent highs, and interest rates will slowly grind higher based on the expanding economy and a conservative federal reserve.
What is unusual about this selloff is both equities and bonds are down at the same time. And while stocks are still up over 3% year to date, as measured by the S&P 500, bonds are down -1.8% as measured by the Barclays US Aggregate index. Normally when stocks experience positive performance, bonds are flat or down, and vice versa when stocks experience negative performance. Since both are down simultaneously, it leads us to believe this is a temporary situation based on the threat of significantly higher interest rates. However, we do not see this threat materializing since although the economy is expanding, it is not doing so quickly enough to drive rates much higher.
Although this market outlook has been prepared from public and private sources and data that LTAM believes to be reliable, LTAM makes no representation as to its accuracy or completeness. Any securities, indices, and other financial benchmarks shown are provided for illustrative purposes only, and reflect reinvestment of income, dividends, and other earnings. They do not reflect the deduction of advisory fees. Indexes are unmanaged and investors cannot invest directly in an index. Investors should bear in mind that past performance is no guarantee of future results and there can be no assurance to achieve comparable results. Investment products are subject to investment risk, including possible loss of the principle amount invested and should review the prospectus before investing. The information and views expressed are given as at the date of the writing and are subject to change. This information is not to be used or considered as an offer or the solicitation of an offer to sell or buy any securities mentioned herein. Ladenburg Thalmann Asset Management Inc. is a registered investment advisor and subsidiary of Ladenburg Thalmann Financial Services Inc. which is traded on the NYSE American: LTS.