What is occurring?
- Volatility is not new, but it is on the rise. On Monday, February 5th the Dow Jones Industrial Average had its largest numerical drop in a single day; however, it was far from its largest percentage drop. It is more important to focus on the percent change than the point change (which the media seems to focus on).
- Market volatility has been at historic lows leading up to last week. The latest price changes have been larger than in recent quarters and the swiftness of the changes caught many market participants by surprise. This can lead to an environment where volatility can overshoot to the upside.
- In addition to volatility being below average for an extended period, other contributing factors to the recent rise in volatility appear to be related to an expected uptick in future inflation and rising interest rates.
What are our thoughts on the market?
- Fundamentally the stock market is (was) not highly over-valued and company revenue growth continues to surprise to the upside – both constructive for longer term stock growth.
- The earnings yield on the US stock market is 5.9%, which is still favorable longer term for stocks compared to the 10 year US Treasury bond yield of 2.80%. Stated another way, a dollar invested in the stock market still buys over 2x the future earnings potential vs bonds.
- Rising inflation and interest rates is not necessarily bad as it can be representative of economic growth. Rapidly rising and/or unexpected increases can however lead to increased market volatility in the short term. The Federal Reserve, which has an influence on interest rates (and inflation), has been transparent and vocal with their intentions. These well-telegraphed messages can be good for limiting surprises.
How is the portfolio positioned?
- Over the past several quarters our investment committee has been making adjustments in anticipation of increasing market volatility. These adjustments were not because we predicted volatility in February 2018, but rather a core part of our process.
- To expand on this, core to how we manage for volatility is by dividing your portfolio into time segments specific to your financial life. Shorter term investments are more stable and focused on protecting from down markets while longer term investments are more growth focused with potentially higher volatility. The main aspect to the weighting of these segments is established based on your financial plan and through our discussions. This practice allows us to effectively navigate through volatile periods while still focusing on the longer term success of your portfolio.
We will continue to provide updates. As always, please contact us with any questions.