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Market Volatility: Stocks Enter Correction Territory

The bull market in U.S. stocks has officially entered correction territory, as several benchmark indexes fell more than 10% below their recent peaks on Thursday. While pullbacks of this size can be painful and continued selling pressure could lead to more volatility in the near term, we would also remind investors that the occasional correction is a normal part of investing.

Schwab Chief Investment Strategist Liz Ann Sonders says the strength in corporate earnings and the pick-up in economic growth are two reasons to think the stock market correction won’t lead to a significantly deeper bout of economic grief. She also notes that the correction has actually helped temper two of the market’s potential problem areas: Over-eager investor sentiment and high valuations.

Overall, we suggest investors stay the course at this time, unless their financial situation has materially changed. That said, you should also consider taking a fresh look at your longer-term investment plan if you haven’t done so within, say, the past year. Sharp selloffs present opportunities to revisit your goals and objectives.

You could also consider using the pullback to rebalance back to your strategic asset allocation. As different markets move, the amount of risk in your portfolio can move beyond the original intent of your financial plan. Rebalancing helps to make sure you’re taking risks consistent with both your emotional and financial situation. 

What sparked this bout of volatility?

Several factors appear to be at work here:

  • Increasing inflation pressures have raised concerns the Federal Reserve could raise interest rates faster than previously expected. We expect at least three rate hikes this year, most likely starting at the March meeting.
  • A rapid rise in Treasury yields—the 10-year U.S. Treasury yield pushed above 2.85%—is starting to affect the prices of other assets.
  • Souring investor sentiment has become a potential source of risk.
  • Other issues, including a weak auction for long-dated Treasuries, concerns about a potential government shutdown and technical issues related to big investors adjusting their positions in the face of increased volatility, may have contributed.  
     

Here’s our take on how this is affecting different parts of the market.

Treasury bond yields have been rising

Ten-year Treasury bond yields have been rising sharply since late last year because of strong economic data, signs of higher inflation and concerns about the Fed tightening policies, says Kathy Jones, chief fixed income strategist for the Schwab Center for Financial Research.

“We expect the Fed will continue to raise short-term interest rates as inflation pressures are building. The Fed is also tightening policy by shrinking its balance sheet, which means the market will need to absorb about $400 billion more in Treasury bond supply this year than in 2017,” she says. “Yields will likely need to rise to attract buyers to the market.”

“That said, when stocks selloff sharply, Treasury bonds tend to rally because they serve as safe haven investments in times of heightened volatility,” she adds. “Riskier bonds, like high-yield and emerging market bonds, are susceptible to declines because they are more correlated with equities.”

Potential implications for international markets

The pullback has hit stock markets around the world, returning global stocks to where they were at the end of last year. But it has had little spillover to related global markets like currencies or commodities, says Jeffrey Kleintop, Schwab’s chief global investment strategist.

“The pullbacks this year are likely to be temporary,” Jeff says “But increased volatility and the advanced stage of the business cycle mean that staying diversified and watching target asset allocations are important.”

The takeaway for traders

The Cboe Volatility Index (VIX), a measure of volatility expectations better known as the fear index, has surged in recent days, from abnormally low levels around the start of the year to its current historically high level, says Randy Frederick, vice president of trading and derivatives for Schwab. Caution is warranted as the VIX’s current level implies expectations of sharp daily swings in stock prices.

“Patience is key. We expect this pullback to eventually create opportunities for those seeking to increase equity exposure because of the backdrop of sound market fundamentals and robust economic activity,” Randy says. “However, traders should exercise extreme patience in the coming days: Wait for a couple of solidly higher days and a decline in the VIX back toward more normal levels before adding to positions.”

The takeaway for long-term investors

Markets typically go up and down, and you’re likely to experience several significant declines during a long investing career. It may be healthier for your portfolio if you resist the urge to sell based solely on recent market movements, although that can be emotionally difficult at times.

Every investor is different, but periods of market volatility can also be a wake-up call to make sure your portfolio is adequately diversified or consider adding defensive assets, such as cash or U.S. Treasury securities, for stability. If you don’t have a financial plan, now might be a good time to talk to a planner about creating one. For more information on steps investors can consider during volatile markets, check out “Volatile Markets? Here’s What You Should Know.”

What you can do next

  • Focus on the long term. If you’ve built a solid financial plan and a well-diversified portfolio, it’s best to ignore the noise and focus on your long-term goals. Market volatility is unnerving, but it’s a normal—and normally short-lived—part of investing.
  • Learn more. Read and watch Schwab’s experts discuss strategies for weathering market volatility. 
  • Talk to us.  Schwab is happy to discuss your portfolio whenever and wherever it’s convenient for you. 
    • Call Schwab Customer Service at 800-355-2162
    • Find a branch or a consultant near you. 
    • Consider Schwab Intelligent Advisory™—our automated portfolio management with professional guidance. You can schedule a complimentary consultation with a Certified Financial Planner™ professional (CFP®) who can help you plan for retirement, college and future market volatility.
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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.

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

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

The Chicago Board Options Exchange (CBOE) Volatility Index shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

International investments are subject to additional risks such as currency fluctuation, geopolitical risk 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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