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A Return to Normalcy?

Market Thoughts 2.6.2018

After returning more than 21 percent last year and jumping up another 7.5 percent through late January, the stock market (as measured by the S&P 500 Index) has declined nearly 8 percent from its close on January 26. This decline in stocks brings us back to mid-November 2017 price levels. You may be wondering what caused the market downdraft we experienced, when this period of volatility will end, and if you should be worried.

Let’s address the last issue first. There is no need to worry. While stocks normally drop from 5 to 15 percent at some point each year, we have not experienced a selloff of this magnitude since early 2016—about two years ago. The stock market was long overdue for a correction.

A stock market correction in the context of a weakening economy could augur a recession, but a correction amid a stronger economy is more likely related to short-term technical market factors. If history is a guide, a correction during a period of economic growth generally lasts up to two months and includes a 10 percent drop. While the S&P 500 approached the 10 percent threshold, it did it in less than two weeks. And despite today’s bounce, it is too soon for the “all clear” signal.

For the past several quarters, most of the world has experienced a synchronized growth surge. We are certainly on the lookout for dark clouds. But, on balance, over last several weeks we have not seen any fundamental changes in the economy that would cause us concern.

Last week’s U.S. unemployment report reflected a healthy increase in the number of jobs created—along with acknowledgement that wages are starting to rise. Measures of economic strength in Europe are very strong. China stimulated its economy last year to facilitate the political reappointment of President Xi Jinping but has begun to rein in excess credit and real estate debt growth. Although we expect China’s growth rate to be strong, we are monitoring for the potential of a deceleration.

That said, we have commented in a recent publication that investors should be wary of the period of relative calm we have been experiencing. With interest rates on the rise and central banks beginning to roll back their accommodative monetary policies, they might expect an uptick in short-term market volatility—back to normal levels.

One thing to note: as the stock sell off intensified yesterday, high-quality bonds rallied. This behavior suggests investors were reassessing their risk appetites and looking for shelter from the storm. That’s indicative of an overextended market and, as always seems to be the case, demonstrates the value of portfolio diversification during times of market stress.

Given the solid underpinnings of the U.S. and global economies, this correction could prove an opportunity for some of our clients who had built up cash in anticipation of a downturn. Our best advice is to stay diversified with a long-term investor’s mindset.

We will continue to focus on the markets and welcome your questions and comments.