Stock markets started the year with an accelerated continuation of the one way staircase higher that they enjoyed in 2017 (see separate “February 2018 Monthly Market Update”). This period was marked by numerous records being broken for the longest period without even a 3% drop. Then, things changed rather quickly. Stocks fell significantly on Friday and followed on Monday with the largest point drop ever. The combination wiped out the strong gains in January. As we write this on Tuesday, stocks are down slightly more.
We wanted to offer some thoughts regarding the current markets.
Short-term: The abrupt reversal in the markets was certainly a jolting wake up call for investors. The S&P 500 is down approximately 8% from its high point in January. This more than wiped out the gains for the year. Global stock markets more or less mirrored the declines in the U.S. Bond yields have been rising for most of the year and that, along with rising inflation fears, is the most often cited culprit for the stock selloff.
Big Picture: While the point drop in the Dow is eye popping and was the largest ever, the decline in the U.S. markets on Monday was only its 100th worst single day drop in percentage terms. The decline leaves the U.S. stock market where it was in December 2017 which was the end of a very good year for stocks. We continue to remind our clients that stock declines of 5-10% will happen very routinely (typically every year). The ultra low volatility of 2017 was more unusual than the recent decline. We went into 2018 expecting low returns for U.S. stocks over a 5-7 year time horizon and have positioned our portfolios accordingly. In the event of an extended decline in U.S. stocks, we would increase our U.S. stock exposure back toward “normal” allocations from the current underweighting. We do not know whether the current moderate decline will turn into that type of bear market. Several arguments against an extended decline is that economic growth is currently strong, corporate earnings are rising, interest rates and inflation are still relatively low, and the recent tax cuts are expected to have a positive impact (at least short-term) on economic growth and corporate earnings. That said, valuations remain quite high and we believe stocks have already priced in much of these positives.
What we are doing: Immediately, nothing. Recent market action has not been significant enough to alter our forecasted returns meaningfully. As we talk with clients, we have been reviewing their current risk tolerance, making sure liquidity is available for expected withdrawals over the next several years, and rebalancing to target allocations where needed. We have been analyzing several potential portfolio modifications prior to the recent market volatility and will contact you should we decide to recommend changes to your portfolio.
As always, we welcome any questions or concerns.
John Lynch Doug Lynch