This week has seen a dramatic decline in the market indexes. The Dow, the S & P and international market indexes are down double digits. As I am writing this, the Dow is just approaching its value on Jan 1 of 2018. So while we have seen a dramatic decline over the last several days, we are only back to where we started just 4 and a half weeks ago.
What is driving this volatility? Here are a few key points to keep in mind:
- Part of the reason for the current volatility in the stock market is the prospect that the Federal Reserve – the central bank of the United States – could potentially raise U.S. interest rates as many as four times this year. This would effectively slow the flow of money, since higher interest rates make it more expensive for individuals and companies to borrow money.
- At the same time, the bond market has seen rising yields since 10-year U.S. Treasury notes hit a low point in July 2016, mainly due to investors being increasingly concerned about inflation. Rising yields are traditionally seen as negative for stocks as they increase companies’ borrowing costs.
Now let’s refocus on the facts:
- Investors have enjoyed two years’ worth of returns in a span of just three or four weeks. Those are not sustainable price moves, so this kind of volatility is normal and should not come as a surprise to investors. It is also important to note that the volatility index (VIX)*, which is a popular measure of the stock market’s expectation of 30-day volatility, has been running well below normal and, like a compressed spring, it could abruptly return.
- To speak to the larger point, market returns are typically driven largely by corporate earnings and broad economic growth. Global growth continues to be strong, while companies around the globe have reported strong results in their most recent earnings reports.
This week’s ‘sell-off’ does not change this fact; we expect strong earnings growth to continue, and anticipate that the Federal Reserve and other central banks around the world will be careful to avoid raising interest rates to the point where they hinder further economic growth.
