Volatility: Don’t Be Fooled by the “Recency Effect"
We tend to remember the most recent events far better than we remember events from the past. Psychologists call this the “recency effect.” Market voltility is normal – yet it was extraordinarily low in 2017, and that has colored what we think “normal” volatility should be. So some perspective is useful when deciding how to react to the very recent uptick in market volatility, with the S&P 500® down -7.7% from its all-time high as this is being written.
Since 1950, the average intra-year correction, or drawdown (the largest market drop from peak to trough) in the S&P 500 has been 13.4%. But in 2017, the largest drawdown was only 3% – the second-smallest drawdown in 70 years (the lowest being 2.5% in 1995). And last week the S&P 500 set a record for the longest period since 1950, at just over 400 days, without a correction of at least 5%. So 2017 was abnormal in its lack of volatility – but because we just lived through 2017, that abnormality became our new normal (the “recency effect”). No wonder the jump in volatility since January 2018 seems shocking.
Some perspective: Here’s where we stand today: The US economy is strong, directly aided by the recent tax overhaul. We are seeing healthy GDP growth (5.4% Q1 initial estimate, Atlanta Fed GDP Now), consumer confidence near a cycle high, unemployment at only 4.1%, gradually growing wages, and healthy corporate profitability (12% earnings growth estimated for Q4 2017 and 16.3% growth for 2018). This is not a time to panic.
Rising interest rates are giving the equity markets an excuse for taking a breather and for investors to take some chips off the table. But consider:
- The Federal Reserve is likely to raise rates at least three times in 2018 to combat inflationary pressures driven by strong economic growth. That pro-spect has helped push short-term rates up.
- The federal government is projected to run nearly a $1 trillion deficit in 2018, up 93% from $519 billion in 2017. This fact, along with inflationary pressure, is helping to push intermediate and long-term interest rates up.
- And yet credit spreads between Treasuries and corporate bonds remain stable – and they normally widen when economic risks increase.
At this time, we do not see signs of larger market and economic concerns.
Undervalued sectors: We continue to see relative value in international markets and value-oriented equities, which have underperformed in recent years. Consider adding exposure to energy/commodity sectors, which have lagged in recent periods, and thematically fit our views toward inflation as a risk.
Most importantly, even though we see no immediate concerns, this is the time to work with your Wealth Advisor to ensure that the risk in your portfolio matches your overall risk profile.
Name To Know
Moon Jae-in - President, Republic of South Korea
Moon Jae-in succeeded an impeached predecessor only last May. Moon is of note this month as South Korea hosts the Winter Olympics; he was instrumental in amalgamating a team of athletes for the Games from both North and South Korea.
Moon also occupies a pivotal position in East/West relations, given South Korea’s highly developed economy and its proximity to less-developed, saber-rattling North Korea.
Important Information about This Newsletter
Each client’s investment needs, risk tolerance, and goals are different. This newsletter is not meant to be advice for any specific investor. Nothing in it should be construed as an offer to sell, or a solicitation of an offer to buy, any securities. This should not be used as the sole basis for an investment decision. Any opinions or estimates are subject to change without notice. For information about how any of this information applies to your personal financial situation, please contact your Financial Consultant.
Past performance is not a guarantee of future results.
Although we obtained or compiled the information in this newsletter from sources that we believe are reliable, J.J.B. Hilliard, W.L. Lyons, LLC cannot, and does not, guarantee that the information or data is accurate, timely, valid, or complete.
All investing involves risk, including the possible loss of principal. You should carefully consider investment objectives, risks, charges, and expenses of any investment before investing. Diversification and asset allocation do not guarantee a profit or guarantee against a loss.
Stock markets, especially foreign markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. The bond market is also volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect can be more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks.