If you didn’t know any better, you might be tempted to think that Groundhog Day was more of a market indicator than a popular tradition around the coming of spring. After all, it was the economic release on the morning of February 2nd that caused the markets to oscillate in a fashion not seen in nearly 2 years.
This type of market fluctuation feels very unsettling, especially when markets have been unusually calm over the past year. During these uncertain times, it’s important for investors to understand that these types of events are normal and can create opportunity for disciplined, long-term investors.
The market turbulence that began on Friday, February 2nd was actually caused by wage and jobs reports that both were very positive. The economic reports indicated that the consumer had more money to spend, which is encouraging news for the economy.
Unfortunately, investors took this good news as an indicator that rising inflation and interest rates could hinder the economy in the future. Investors were also concerned that the good news would cause the Fed to raise rates faster than previously expected, which would be a headwind to the economy.
Perception versus Reality
It’s true that high inflation or interest rates can harm an economy. But the important distinction for investors to make is that there is a distinct difference between rising inflation and high inflation. In recent years, the Fed has been struggling to get inflation above 2%. Despite the recent fears, inflation is still hovering around 2%. Inflation is markedly lower than the historical average above 3%.
The same can be said for interest rates as the 10-year treasury yield remains below 3%, which is considerably lower than its historical average. It is healthy for inflation and interest rates to rise as an economy grows. Given both metrics remain well below their historical averages, we don’t believe they represent a material impediment to a growing economy.
Normal versus Abnormal
Since late January, the U.S. market has experienced a 10% correction. A glimpse at the record books shows that the market averages a correction once a year. The last market correction occurred 2 years ago in February 2016, so we were overdue for this type of pullback. Trees don’t grow to the sky and neither do markets. Despite the setback recently, the U.S. market has had a terrific 2-year performance up more than 50%. Market declines are a normal part of investing especially after such a successful 2-year run.
Last year was an unprecedented year for investors. U.S. markets finished up more than 20%, doubling their long-term average return. Despite averaging a 10% correction each year, markets were extremely tranquil as our largest pullback last year was a meager 3%. This context can be helpful for investors to realize that the recent market volatility is part of a normal market cycle. Moreover, what actually proved to be abnormal were the exceptional returns and muted volatility of 2017.
As we look to the remainder of 2018, market fundamentals give us reason for optimism despite the recent volatility. With low unemployment, wages growing, and GDP trending higher among other positive indicators, the economic growth story should continue to strengthen this year.
Corporate earnings grew at a double digit pace in 2017 and are expected to see their fastest growth this year since 2010. Given the sound fundamental backdrop and seemingly no recession on the horizon, we believe the recent market decline presents long-term investors with a nice buying opportunity.
Focus on your Plan
With all the calm prior to the recent market volatility, the past few weeks have felt like stepping out on the first cold day of winter after a mild fall. In the short-term, we would caution investors to expect more volatile days as volatility usually breeds more volatility. However, it’s critical to put perspective around the recent market decline.
These pullbacks are normal and healthy for an expanding economy and can provide opportunities for disciplined investors. Long-term investors should avoid letting short-term market noise affect their long-term financial plan. If your financial goals, risk tolerance, and time horizon have not changed, neither should your investment strategy.