The Return of Market Volatility: Recent Market Action an Opportunity or Risk?

 In Strategy Updates

Stock market volatility is back. After 18 months of historically low market volatility, investors are getting a dose of market swings that haven’t been witnessed in some time. Though the downside and upswings in recent weeks are still well within what we consider “normal” percentages, these movements represent an astonishing number of Dow Jones Industrial points – a mere 1% move is the equivalent of 260 points! Moreover, and a bit more unusual, is the speed by which markets have been moving within this volatility. 5% moves down or up within a few days is above average even by historical standards. Does this return of volatility and faster paced trading signal danger ahead? Or is this opportunity knocking for those investors who have missed the last year of great returns? This type of volatility inspires our team to “dig in” to the fundamental data underlying these market movements so that we may glean whether stock prices are still attractive at these levels.

Is it the economy?

On the economic front, we haven’t seen the US (growing at 3% annually) and global economy (growing at 3.6% annually) this healthy in 10 years. This has stimulated job and wage growth to historically high levels and been a big driver of corporate profits. This quarter alone over 85% of US companies reported better than expected profits. Economic activity has been gaining momentum which is not what we would see prior to an economic recession – the big risk for stocks.

Is it the Federal Reserve?

The Federal Reserve has recently raised interest rates and suggested that they may do so 2-3 times more this year, given the robust economy. This is a prudent strategy. Left unattended, strong growing economies tend to create inflation which is another devil for stock prices. So on this front, Jerome Powell and his team at the Fed appear to have this well under control.

Are stocks overpriced?

Here is where it is easy to make a case for being in the stock market. The current price to earnings ratio (P/E Ratio) of US and global stocks is a mere 16 times forward earnings. This is not a level that has ever been associated with the beginning of a bear market. Moreover, in a strong, growing, solid global economy this number represents opportunity!

In the context of empirical data, we have a sound economic backdrop, good earnings growth and a very reasonably priced stock market. Though recent downside has felt dramatic, market indexes have simply given up the profits of January’s meteoric rise and are, in most cases, just slightly down for the year. The media’s attention to the recent volatility has not helped, as they too became spoiled by the low volatility of the past year and now find it necessary to overindulge in espousing fear. Our counsel during these periods is to remind you to look at percentage changes, not dollar amounts or index points, when reviewing your portfolio to keep this volatility in perspective.

Should we be wrong about our current robust economy and market data take an abrupt turn for the worse – we continue to apply our Active Risk Management process. This entails your portfolio’s allocation to stocks, sector exposure and the use of carefully placed stop loss orders, all of which are intended to mitigate catastrophic losses.

We hope this update finds you well. If you have recently experienced any significant changes in your financial situation or would like to review your portfolio, please let us know. As always, if you have any friends or colleagues who you feel may benefit from our services, we would be happy to introduce ourselves to them with a no-obligation introductory meeting.

Thank you from all of us on the team for your vote of confidence in our work!

Your Team at Main Street Research