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The Case of the Missing Volatility – SOLVED!

1Q 2018

Wow – what a difference a few weeks can make! Our prior market commentary (written at the beginning of January), entitled The Case of the Missing Volatility, became very prescient a few short weeks later. It discussed the abnormally low level of volatility seen in the market for 2017. As we saw the end of January close in, world markets became quite choppy.

In the first quarter, the S&P 500 experienced six trading days where market movements were greater than +/-2% in a day. In 2017 there was not a single trading day with the same level of volatility. Then we returned to “normal…”

(Click to enlarge)

Many items played a role in the volatility during the quarter. It all kicked off with fears from the January jobs report that perhaps inflation was beginning to creep up on us. This was a change from a fairly long period of low, stable inflation. The concern was a higher than expected wage growth figure that might lead the Federal Reserve to raise interest rates faster than investors had previously thought, which could put the brakes on the economic expansion. After a few weeks, things settled down following economic data implying the January inflation reading may have been affected by one-time items associated with the newly-enacted tax bill.

A few weeks later, President Trump would announce US steel and aluminum tariffs, which was quickly followed by the departure of his top economic advisor. Eleven days later President Trump would fire his Secretary of State, and nine days after that he announced tariffs on $60 billion worth of Chinese goods.

In the midst of all the headlines coming from the White House, news broke on March 17th about the Cambridge Analytica-Facebook scandal which triggered a sharp selloff in big technology names on fears of increased regulation. The quarter concluded with the President noting that he has ‘concerns’ about how big and powerful Amazon has become.

During a period where stocks were down (the S&P 500 finished -0.8% and the MSCI EAFE, or international stocks, were -1.5%), investors would normally expect diversification to help, but in the first quarter bonds (which usually offset stock losses with gains) were also lower (-1.5%) following a sharp rise in interest rates. But rather than investors abandoning diversification, they should embrace it. Volatility creates opportunities. Over the long term, fundamentals drive markets, and US fundamentals remain relatively healthy. Profits are rising and following the recent volatility stocks have become less expensive.

We encourage investors to filter the noise and stay focused on the long-term. Maintaining diversification, rebalancing where appropriate, and sticking to your plan are the best ways to benefit from turbulence and enhance long-term outcomes.

 

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