By Linda S. Parenti, CFA
President & Chief Investment Strategist
Wow, what a difference in market behavior from just a few weeks ago! The stock markets went for over a year without even a 3% pullback; then seemingly overnight, volatility came rushing back as we began February. Market movements have somewhat settled down this week, which is welcome. Some of the contributing factors that intensified the sharp declines seen last week have diminished, lessening the chance we will see a repeat. However, I also do not expect volatility to return to the unusually low levels of the previous year. That smooth period was nice while it lasted, but unfortunately experiencing pullbacks and corrections are a normal part of equity investing.
It seems everything is returning to normal these days. The Federal Reserve is on a path of normalizing monetary policy by gradually increasing short term interest rates from historically low levels. Inflation is rising to more normal levels, and expectations for this to continue have finally started to push longer term yields higher. This means we are now seeing a normalizing (steepening) of the yield curve where long term rates are reasonably higher than short term rates. A steeper yield curve is a good indicator of continued economic growth ahead. Fourth quarter results for S&P 500 companies continue to show better than expected earnings and sales growth. With earnings higher and stock prices lower due to the recent pullback, valuations moved closer to more normal levels. Bullish sentiment is also off the highs reached in January, which is a healthy sign that investors have regained a measure of skepticism.
So, if everything seems to be heading in the right direction, why are markets so skittish? That is a very good question. I believe the return of volatility lately reflects technical and mechanical trading patterns, rather than fundamentals. Even during the trading days with the biggest declines earlier this month, we did not see panic in credit markets or the flight to safer assets typical during a crisis. Fundamentals globally remain supportive of economic growth. Interest rates and inflation are rising, but from still very low levels. Employment is strong, fiscal policy is supportive, and small business optimism is high. This all paints a positive picture for equities even with added volatility. From our perspective, this return to more normal market patterns should allow additional opportunities for long-term investors.
RISKS AND IMPORTANT CONSIDERATIONS
Views and opinions expressed here are for informational and educational purposes only and may change at any time based on market or other conditions or may not come to pass. This material is not a solicitation to buy or sell securities and should not be considered specific legal, investment, or tax advice. The information provided does not consider the objectives, financial situation, or particular needs of any specific individual. All investments carry a degree of risk and there is no certainty that an investment will provide positive performance over any stated period. Equity investments are subject to company specific and market risks. Equities may decline in response to adverse company news, industry developments, or economic data. Fixed income securities are subject to market, credit, and interest rate risks. As interest rates rise, bond prices may fall. Past performance is no guarantee of future results.