After more than 18 months of nearly uninterrupted advances, the U.S. equity markets started declining last week, followed by even more extreme selling on Monday. Although it is always difficult to endure declines when they’re occurring, it’s important to focus on the underlying fundamentals of the economy and the markets, which are pointing to the potential for continued growth in 2018 and beyond.
There are several conditions that help explain this current sell-off. The biggest factor is a stronger than expected January jobs report showed rising wage pressures, which has increased concerns about inflation and possible changes to monetary policy. Certainly, employee costs make up the largest percentage of business expenses, which are typically passed on to consumers in the form of higher prices.
Inflation can also subtract from the “fixed” income offered by bonds, causing investors to demand higher yields. In these instances, the Federal Reserve (Fed) usually attempts to slow down demand by raising interest rates. Thus, investors may now fear that monetary policymakers will increase rates more than expected in 2018.
As market interest rates started to climb in response to the wage growth concerns, this triggered further selling among some of the crowded trades. Also contributing to overall investor concerns, further deficit spending measures loom as federal budget negotiations continue, with the potential for another government shutdown set for February 8, 2018. Finally, several leading technology and energy companies reported disappointing profits, despite an otherwise strong earnings season.
While market volatility is never pleasant, it is important for investors to appreciate that market pullbacks are a normal part of investing, and we have not experienced even a 5% drop in the S&P 500 Index since the Brexit vote in June 2016.
Indeed, the markets have produced a series of record-setting gains recently amid an absence of volatility. Also consider that volatility has historically increased in midterm election years and the market has a propensity to test new Fed chairmen. Given these developments, this market weakness may have been overdue.
One thing that we all have to remember, as investors, is that market volatility can still occur in healthy markets. Remaining focused on the underlying fundamentals supporting the economy and markets, while maintaining a long-term view, is a valuable strategy toward a better position for potential success.
As always, I encourage you to contact me with any questions.
Bryan Foronjy, CFP®
Founder and Principal Wealth Manager
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