February 7, 2018 | Client Communication
After an exceptionally strong year in markets, volatility has struck back in recent days. At the time of this writing, the S&P 500® Index has fallen roughly 10% from its record close on Jan. 26. Many folks are asking if this is the start of a bear market. My answer—probably not.
Bear markets are almost always caused by a decline in the real economy. That’s because it takes a recession to simultaneously damage both the valuations multiples AND earnings growth of businesses. And right now, this does NOT look like a recession scare to me. Instead, two distinct forces are conspiring against global equities.
- First, the high frequency U.S. data suggests inflation is starting to re-accelerate—wage inflation in the January employment report surprised to the upside and touched its highest level since 2009. This pushed the 10-year U.S. Treasury yield up to its highest level in four years. Higher discount rates are proving to be a challenge to the elevated valuation levels of U.S. stocks.
- Second, investor sentiment has taken a hit—market psychology was bordering on euphoria in late January and is coming back down to earth now. For example, the share of respondents expecting stock prices to increase in the Conference Board’s Consumer Confidence Survey hit an all-time high in January. Russell Investment’s research teams have also pointed to evidence that a lot of the selling activity has been driven by technical reversals in trend-following strategies. A step back toward rationality should be a healthy development for the market outlook.
Economic and earnings fundamentals, by contrast, are actually quite robust at the moment. The J.P.Morgan Global Manufacturing PMI™ hovered close to an 82-month high in January. And the fourth quarter corporate earnings season in the U.S. is tracking ahead of schedule—over 80% of S&P 500® Index companies are beating consensus revenue estimates (i.e., one of the highest beat rates in many years), and earnings growth is tracking north of 13%. Indeed, recent economic trends in Europe and Japan are even stronger than the United States.
Bottom line: We will continue to monitor economic and market conditions carefully in the coming days. But for the time being, this looks like a healthy correction in the markets, rather than the onset of a bear market. Depending on the depth of the dip that we see in asset prices, this selloff could create an attractive entry point for investors to take more risk.
As always, we’re here for you,
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There, I said it.