Feb 05, 2018

Equity Markets Fell Sharply Monday

By Bob Landry

Equity markets in the U.S. fell sharply again on Monday, with the S&P 500 off approximately 4.1%. This comes on the heels of a rough stretch last week where the index finished lower by 3.9%, its worst weekly performance in two years. Global markets also have traded lower in sympathy.

Although pinpointing a specific catalyst for a decline is always difficult, it appears investor angst over the recent run-up in bond yields is the key variable. The yield on the 10-year U.S. Treasury note, which started the year at 2.41%, climbed to a roughly four-year high of 2.84% Friday on the prospects for stronger economic growth and higher inflation. This may call into question expectations that the Federal Reserve will raise its policy rate (the federal funds rate) only three times this year.

Although such a decline may be disconcerting to investors, it is important to keep the following points in mind:

  • This is not necessarily a signal that the bull market has come to an end. A pullback of this magnitude is quite normal historically and I would say, healthy. It’s important to maintain perspective.

    • The last one-day decline prior in excess of 2% prior to last Friday occurred on September 9, 2016.
    • According to InvesTech Research, on average since 1932, a correction of 5% or greater occurs about every 7 months, a 10% or greater correction occurs once about every 26 months, and a bear market (a correction of 20%+) occurs about every 3.8 years.
  • The U.S. economy remains sound. Corporate profits and wages are rising, inflation remains low, and the positive influences of the recent tax overhaul are yet to take effect. We do not see a recession on the horizon. A bear market would be very unlikely absent the U.S. economy in recession.
  • Stock market volatility has been unusually low for months and therefore was vulnerable to a sharp reversal. Wringing some of the excesses out of the market is beneficial.
  • Rising bond yields could represent another head fake. Market pundits and prognosticators have been fooled on numerous occasions in recent years by yield increases that eventually reversed.
  • The news media have a tendency to overdramatize such market moves and investors tuned into CNBC or Bloomberg TV will be bombarded with commentary from hosts and guests who will tend to reinforce their fears.
  • Although it is impossible to predict where the market will go from here, the recent decline should serve to remind investors that an investment in stocks is not a one-way ride.

When looking at a chart of long-term equity market performance, declines like those experienced last week are barely perceptible. Investors should focus on their long-term investing objectives because even if this ends up being the beginning of a meaningful correction, stocks remain the best way for investors to build wealth over time.

If this decline has you questioning your willingness and ability to tolerate a further meaningful drawdown in stock prices, it is important to discuss this with your adviser. A nine-year bull market that has experienced few sizable pullbacks can lull us into complacency with respect to our true risk appetite. It’s not too late to reassess.

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