The last few days have been marked by an increase in volatility and a return to risk-off behavior which has resulted in a significant correction to global markets. While we certainly have our concerns regarding the events of the past week, we felt it was necessary to highlight the following salient points regarding our perspectives on the market and global economy. We feel that the current negative sentiment may continue for the coming days, however our outlook on the economy has not changed, and we remain cautiously optimistic on the markets in 2018.
- As we have mentioned numerous times in our investment commentary, this market was long overdue for a correction, as we hadn’t seen more than a 4% drop since October of 2016. The market started off 2018 on a fabulous note, as the S&P 500 finished up 5.73% in January, and just yesterday we entered negative territory for the year.
- The selloff was precipitated by an increase in the 10 year yield and higher inflation expectations. To put things in perspective, the 10 year yield is now 2.74%, which is hardly ominous from a business lending perspective, having climbed from about 2.43% at the beginning of the year.
- Another culprit is likely the rise of passive investing, coupled with over-complacency, as volatility has been so low for so long. The selloff seemed to materialize in a machine like fashion, with no fundamental backing or headline news (outside of rise in rates) to justify the price drop.
- Interesting to note, while rising rates were one of the catalysts to this selloff, rates have actually fallen as the equity correction escalated. We believe this was caused by a flight to quality trade as investors rotated into high quality U.S. treasuries, something we anticipated last month and why we added to our AAA bond exposure in our most conservative bond models.
- Fundamentally, we believe that nothing has changed. The U.S. corporate earnings season has been particularly strong, as so far 75% of the companies in the S&P 500 have reported positive earnings surprises, and 80% have reported positive sales surprises. Manufacturing surveys remain strong across the globe, and with easy monetary policies continuing overseas we believe this cycle still has room to run.
- It is important to remember that markets can and will act irrationally at times, sometimes for extended periods. While an 8% drop in the markets is certainly noteworthy, we are still cautiously optimistic that due to the strong global economy, this market will stabilize. While there may be more pain to come in the coming days, we advise not to panic as we keep the overall health of the economy in perspective.