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Market Volatility: Schwab’s Quick Take

U.S. stocks fell sharply Wednesday after the April consumer price index (CPI) saw its largest monthly gain (+0.8%) since 1982 and its largest year-over-year gain (+4.2%) since 2008, stoking investor fears that inflation is becoming a larger and more persistent issue. The S&P 500® Index fell 2.1% and the Nasdaq fell 2.7%, with all equity sectors except Energy declining.

U.S. stocks: Speculative stocks tumbled while investors sought higher quality

  • Speculative pockets in the market continued to lose air. Speculative groups—such as non-profitable tech companies, the most-shorted stocks, and newer IPOs/SPACs—peaked in mid-February and remain in either correction or bear market territory. Sectors with higher price-to-earnings ratios (like Consumer Discretionary and Information Technology) have seen similar weakness as investors continue to move into value-oriented and higher-quality areas.
  • Some weakness may be from a re-rating in expectations for growth. Though it’s unlikely that U.S. economic growth has peaked quite yet, the final round of fiscal aid is now behind us and easy comparisons to last year (for key data such as earnings) will fade after summer. Peak growth rates are more of a reality this year.

 

Global stocks: A brightening European forecast gave global stocks a boost

  • International stocks bucked today’s downtrend. The STOXX Europe 600 Index managed to remain in the green, while U.K.’s FTSE 100 Index rallied 1%. Most sectors posted a gain with a notable lift from Energy stocks as sliding inventories bolstered oil prices. However, the sharp rise in the dollar was a drag on the outperformance, on a dollar basis. 
  • The European Commission raised its forecast for Europe’s economy today. The pickup in the pace of vaccinations, reopening of economies and stronger global outlook all contributed to the increase.

 

Bond markets: Yields could continue climbing

  • Yields could rise further if the rise in inflation isn’t transitory. After pausing for a few weeks, yields could resume their upward trend if growth and inflation readings continue to come in higher than expected. In particular, the 10-year Treasury yield—which has already risen to 1.69%, its highest level since April—could continue to rise to around 2% to 2.5%, based on the Federal Open Market Committee’s projected “terminal rate” of around 2.5%. Given our outlook for modestly higher long-term yields, investors should continue to favor a below-benchmark average duration.
  • Lower-rated bonds could suffer price declines if the threat of higher interest rates persists. Although easy fiscal and monetary policies should support the corporate bond markets, a “risk-off” event in which investors flee to safety could potentially drive prices in the high-yield market lower.

 

Interest rates: A Federal Reserve rate hike is still unlikely in the near term

  • The Fed is unlikely to raise rates soon. Before the Fed raises interest rates, it would first need to reduce, and ultimately end, monthly bond purchases. While the threat of higher inflation could accelerate the Fed’s first rate hike, any hike in 2021 or early 2022 remains unlikely.
  • The Fed has shifted how it manages inflation. After years of missing its 2% target, the Fed is now allowing for an overshoot of 2% to make up for the undershoot. A few months of high inflation readings is unlikely to prompt the Fed to do an about-face and revert to its old approach.
  • Interest rates for consumer loans, such as auto loans and business loans, should remain low. However, mortgage rates—which are generally tied to long-term Treasury yields—could continue to rise modestly if long-term Treasury yields keep climbing.

 

Trading takeaways: Key support levels were challenged and volatility rose

  • This week’s selloff left the S&P 500 at its lowest close since April 1st and down 4.0% in just the last three sessions. The Technology-heavy Nasdaq Composite was hit even harder (-5.2%), closing at its lowest level since March 25th and leaving it up a mere 1.1% year-to-date.
  • Key technical support levels were threatened or breached. The S&P 500 closed just above its 50-day simple moving average (SMA) of 4,050 while the Nasdaq Composite fell through its 50-day SMA on Monday and its 100-day SMA on Tuesday.
  • Volatility rose this week. The Cboe Volatility Index (VIX) rose 27% on Wednesday to a nine-week high and moved above its 50-, 100- and 200-day SMAs for the first time since early March. At its current level, the VIX is implying daily moves in the S&P 500 index of 59 points per day in either direction.
  • Equity traders should consider reducing average share size and dollar amounts per trade and exercise caution before buying the current dip, as it may not be over yet. It is generally best to wait for at least two consecutive solid “up” days before adding equity exposure.

 

What should long-term investors do now?

Market volatility is unsettling, but historically not unusual. If you’ve built an appropriately diversified portfolio that matches your time horizon and risk tolerance, it’s likely the recent market drop will be a mere blip in your long-term investing plan.

However, it can be hard to do nothing when markets are rough. Given what has been happening recently, consider a few of our investing principles:

  • Don’t try to time the markets. It’s nearly impossible. Time in the market is what matters. While staying the course and continuing to invest even when markets dip may be hard on your nerves, it can be healthier for your portfolio and may result in greater accumulated wealth over time.
  • Build a diversified portfolio based on your tolerance for risk. It’s important to know your comfort level with temporary losses. Sometimes a market drop serves as a wake-up call that you’re not as comfortable with losses as you thought you were, or that a portfolio you assumed was appropriately diversified in fact isn’t. Schwab clients can log in and use the Schwab Portfolio Checkup tool to quickly assess whether their portfolio is still in balance with their target asset allocation. If you’re not a client, or haven’t yet established an investment plan, our investor profile questionnaire can help you determine your profile and match it to an appropriate target asset allocation.
  • Ignore the noise. It’s hard to shift your attention when headlines and TV news are focused on the market drop. However, markets historically have fluctuated and recovered. It’s important to stay focused on your plan and track progress toward your goal, not short-term performance.

What You Can Do Next

  • Read more about Schwab’s perspective on current markets.

  • Schwab clients, please reach out if you’d like discuss your portfolio. Contact your Schwab Financial Consultant or call us at 800-355-2162. Because market fluctuations may mean longer call wait times, remember that you can find fast answers online to your most common questions.

  • If you’re not a clientlearn how Schwab can help you reach your goals.

Important Disclosures:

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.  Supporting documentation for any claims or statistical information is available upon request.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Investing involves risk including loss of principal.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. For more information on indexes please see www.schwab.com/indexdefinitions.

Diversification, asset allocation, and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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