Stocks have taken a series of hits in recent weeks. One week, the culprit seems to be the concerns revolving around a handful of tech stocks. The next, tough rhetoric and concerns about tariffs and global trade are in the spotlight.
It’s a lot to take in and scary talk on TV and in the news doesn’t help. Still, it appears to be taking a toll: The S&P 500 Index is down about 8% from its all-time peak in late January.
So it may help to take a step back and consider all the recent volatility in context.
Not a machine
The first thing to keep in mind is that the stock market isn’t a simple machine that responds predictably to single causes. It’s more of a complex system reflecting millions of individual buy and sell decisions based on countless criteria. Its movements are the result of rational assessments of company, industry and economic fundamentals, as well as raw emotion.
While the headlines might attribute the stock market’s moves on a given day to a single cause, it’s best to think of such explanations as being highly selective and simplified. Even amid talk of a selloff, it can be helpful to remember that for every seller, there must also, by definition, be a buyer out there.
A long run
At the same time, the current bull market in stocks just turned nine and we are also in the later stages of the current economic cycle.
“Fundamentally, our view expressed in our 2018 outlook, which was published in December, was that market volatility would escalate this year—consistent with late-cycle economic and market tendencies,” says Liz Ann Sonders, chief investment strategist at Schwab. “Aside from headlines around tariffs, trade and tech stocks, where we are in the economic cycle has big implications for inflation and monetary policy that are also affecting the market.”
“Short-term interest rates are on the rise courtesy of a Federal Reserve (Fed) which has been hiking rates since December 2015, and longer-term rates are generally rising as well,” she says. “I’ve been hearing concerns from our investors about whether this flattening of the yield curve is signaling slower growth ahead or even a heightened risk of a recession. The reality, at this stage, is that it more likely just reflects the ongoing ‘normalization’ of policy by the Fed.
“The notion that the current flattening portends economic doom is misplaced. An inverted curve, not a flattening curve, tends to signal recession—and typically after the inversion.”
But that’s just one part of the economic picture.
Sentiments and signs
One effect of the recent volatility has been to dent investor sentiment—in ways that could actually be helpful.
“Overly-optimistic sentiment had been a factor behind our more cautious outlook for 2018, so an easing of the froth that had accompanied the all-time highs for the major equity indexes back in January is welcome,” Liz Ann says. “One possible side effect has been that historically high valuations have now moved a little closer back to the historical median.”
At the same time, the recent headlines have pushed economic developments to the back burner, while earnings season is also beginning with less fanfare than typically seen. While some of the recent economic data has looked soft, this isn’t surprising given the experience of recent decades: First quarter weakness tends to be followed by a pick-up in the second quarter. The recent data has also had the effect of lowering the expectations bar, which should help as we head further into the second quarter. Surprises tend to make a splash in markets.
And many gauges of the economy still look pretty good.
Both the manufacturing and non-manufacturing Institute of Supply Management (ISM) indexes remain well above the 50 mark, meaning business conditions are improving. And the manufacturing reading reported the largest backlog of orders since May 2004, a key leading indicator for the economy historically.
Unemployment also remains at historical lows, wages continue to expand modestly and business confidence is high.
Turmoil in perspective
In other words, while conditions have been volatile and monetary conditions are tightening, the economy is still pushing ahead in ways that should support stocks. The picture may be mixed, but it’s far from the turmoil you might expect after taking in the news.
“Investors are best served when grim headlines are in the news by again keeping things in perspective,” Liz Ann says. “They should avoid overreacting to geopolitical developments and stick to their long-term financial plans.
“Volatility is likely to remain high this year so investment discipline remains essential. Panic is not an investment strategy.”