February 9, 2018 | Client Communication
After an epic run that saw the S&P 500 Index price rallying 59% from its February 2016 low of 1,810 to the recent high of 2,873 without so much as a 5% correction, I suspected that when a drop did come, it would be sharper than normal.
It has finally happened.
The reason for the sell-off seems simple enough: The stock market has finally started to pay attention to the bond market again. Bond interest rates are an essential piece of the equity valuation puzzle, as higher rates decrease the perceived value of future earnings and put pressure on profits.
The silver lining to the stock market now suddenly being held captive by the bond market is that it is much better for stocks to start paying attention to rising rates now, rather than keep ignoring them and suffering a much worse fate later, as it did in 1987.
Whether the recent correction ends in days or weeks to come is of course unknowable. My guess is that the market chops around for a while, perhaps several months, as typically happens after the economy reaches a momentum peak.
For the typical investor, it’s worth remembering that part of the value of the stock market is that over the long run, equities generate better returns than less risky investments (like money market funds or bonds) but that the “cost” of those higher returns is higher volatility. In that respect, nobody should view the 52% return for the S&P 500 over the last 2 years—amid record low volatility—as normal.
So I for one am not concerned that the stock market is starting to behave like its normal self again.
For investors with an appropriate investment plan based on their risk tolerance, goals, financial situation, and timeline, short-term volatility shouldn’t require any action. I myself am relieved actually. Better a correction now than a bear market later.
Have a great weekend,
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There, I said it.