The U.S. stock market, as measured by the S&P 500® Index, on Tuesday posted its largest single-day drop since August 2017, declining by 1.1% and adding to Monday’s 0.6% decline.
Schwab Chief Investment Strategist Liz Ann Sonders says the sell-off was mostly attributed to a jump in U.S. and global interest rates, as well as a 2% drop in health-care stocks following the announcement of a health-care initiative/partnership between Amazon, J.P. Morgan and Berkshire Hathaway. Month-end rebalancing among institutional funds, including pension funds, and profit-taking by individual investors may also have contributed to the decline.
Is this the beginning of a much worse market downturn? Probably not, Liz Ann says.
“The steady, rapid ascent of stocks led to elevated levels of investor sentiment, and the sell-off could persist in the near term as that unwinds,” Liz Ann says. “However, the risk of a more severe correction is limited due to strong fundamentals, including earnings and economic growth. Also, the market drop over the past two days will likely ease the excessively optimistic sentiment conditions.”
Bond yields have risen
Rising bond yields likely contributed to the selloff in the stock market. Bond yields have moved higher around the globe on prospects for stronger growth, rising inflation and more rate hikes by the Federal Reserve.
“We expect yields to continue moving higher this year,” says Kathy Jones, chief fixed income strategist for the Schwab Center for Financial Research. “However, Treasury bonds could rally—that is, prices could rise and yields, which move inversely to prices, could decline—if stocks and other risk assets decline sharply because the bond market is seen as a safe haven during times of volatility.”
Riskier bonds—such as high-yield and emerging-market bonds—are likely to underperform Treasury securities if stock markets decline further, Kathy says.
The Federal Reserve’s policymaking arm, the Federal Open Market Committee (FOMC) is meeting this week. Kathy says it’s unlikely the FOMC will decide to raise short-term interest rates again at this meeting.
“We expect the Federal Reserve to continue raising short-term interest rates as long as the signs point to higher inflation and an improving economy,” Kathy says. “We expect three rates hikes this year, most likely starting at the March meeting.”
What long-term investors should consider now
After a very strong post-election run-up in stocks, a pullback may serve as an opportunity to review your long-term strategic asset allocation, says Mark Riepe, senior vice president of the Schwab Center for Financial Research. Volatile markets can sometimes reveal that portfolios their owners thought were appropriately diversified in fact aren’t. Other investors may realize that they aren’t as willing to face a sharp drop in the value of their portfolios as they had thought they were.
“Investors may want to revisit their financial plans,” and consider speaking to a financial planner, Mark says.
However, market volatility doesn’t mean investing principles should change, Mark says. For example, it’s generally a good idea to resist the urge to sell based solely on recent market movements. Selling stocks when markets drop can make temporary losses permanent. Staying the course, while difficult emotionally, may be healthier for your portfolio. This doesn’t mean you should hold on blindly, but Mark suggests taking into account an investment’s future prospects and the role it plays in your portfolio, rather than being guided by noise and fear.
If you haven’t rebalanced your portfolio for a while, this is also something to consider now, says Jeffrey Kleintop, Schwab’s chief global investment strategist.
“The sell-off was wide-ranging across countries and asset classes,” Jeff says. “While global economic and earnings growth remain strong, sentiment among investors and business leaders in Europe and Japan recently rose to 15-year highs, after years of pessimism. These high expectations now make stocks more vulnerable to pullbacks if investors are disappointed. The heightened potential for pullbacks makes it increasingly important to rebalance portfolios.”
The takeaway for traders
The Cboe Volatility Index ($VIX) has spiked from all-time lows just three weeks ago to five-month highs this week. However, even at these levels it remains well below its long-term average and does not represent investor panic at this point, according to Randy Frederick, vice president of trading and derivatives for Schwab.
“A 2% to 3% pullback following an 18-month period in which no pullback exceeded 5%, is a normal, healthy occurrence in a bull market, and only reverses gains made in the past couple of weeks,” Randy says. “While disruptive to shorter-term trading strategies, such pullbacks can, and often do, create opportunities for those seeking to increase equity exposure, as market fundamentals remain sound and economic activity robust. However, traders should exercise patience before adding to their positions as it is far better to miss the bottom buying on the way back up than to miss it buying on the way down.”
What you can do next
- Market volatility is unnerving, but it’s a normal—and normally short-lived—part of investing. 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.
- Explore additional strategies for dealing with market volatility.
- Want to talk about your portfolio? Call our investment professionals at 800-355-2162.