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What’s Behind Big Market Moves?

By: Kate Warne, Ph.D., CFA January 16, 2019

Long-term investors know to be prepared for market volatility, but large daily swings like we’ve seen recently can test any investor’s patience. What do these big daily moves mean?

Volatility reflects uncertainty

We expected a return to more normal volatility, but you may have been surprised by the unusually large daily and intra-day stock market moves that started late last year and have continued into early 2019. The Dow rose more than 1,000 points on December 26 – which was a record point increase – but then dropped 650 points on January 3 and rebounded almost 750 points on January 4.

These large daily and intra-day moves are bigger than usual – both in percentages and points. They reflect a lot of uncertainty about current policies and the outlook – but it’s important to remember that this type of turbulence is nothing new, and it’s not unusual when we’re in the later stage of a bull market. It’s uncomfortable, and you may feel the need to react emotionally, but we don’t think these moves are a sign of trouble ahead.

No January thaw

We think volatility is likely to stay high because none of the issues causing the uncertainty and anxiety have been resolved. In addition to more significant political disagreements in Washington, there are three main worries:

  1. Prospects for slower global economic growth, especially in China, which may be knocked down further if the trade and tariff issues aren’t resolved quickly
  2. The possibility the Federal Reserve will raise short-term interest rates too quickly or too much, removing one of the pillars supporting modest U.S. economic growth
  3. A potential U.S. recession on the horizon

In our view, expectations have become too pessimistic and risks are better balanced than they may seem. Although global economic growth has slowed more than expected, it remains positive. And stimulus policies in China and increased government spending in Europe and other areas are likely to improve the prospects for global growth this year. The Fed has emphasized that it remains flexible and patient, and is paying close attention to the data. And we don’t see signs of a recession in 2019, especially with solid job growth and continuing fiscal stimulus.

The Fed and interest rates

December’s interest rate hike was one trigger for volatility, and perceived small changes in the outlook for the path of interest rates are contributing to continuing volatility. The Fed has continued to emphasize that it is not trying to slow the economy and will depend on the data, which we think is a good stance for the markets. Fed chair Powell has talked about staying flexible. It’s important to remember that interest rates are still low compared to historical averages, and the economy is still growing faster than its average pace during this expansion.

In addition, long-term interest rates declined along with stocks, as bonds have continued to help stabilize portfolio values. Lower rates should improve the outlook for rate-sensitive sectors such as housing and autos. And the yield curve remains flat but not inverted, as investors remain uncertain about the path of short-term rate increases in 2019. That’s consistent with our outlook for modest economic growth in 2019.

Although all these worries are likely to continue to produce short-term turbulence, the fundamentals of economic and earnings growth have remained positive. Lower stock prices improved valuation measures such as the price-to-earnings ratio, which indicates stocks are no longer expensive. We think these positive fundamentals are likely to help stabilize the markets as well as support rising stock prices over time.

What’s the upside?

  • Job growth remains extremely strong, with more than 2.6 million jobs created in 2018, and the unemployment rate is near a 50-year low.
  • Consumers remain confident and are spending, which represents about 70% of economic growth.
  • Fiscal policy will add to economic growth in 2019, which we think will remain above-average for this expansion.
  • Although earnings for companies in the S&P 500 are slowing from more than 20% in 2018, earnings growth looks likely to remain above average in 2019 as companies continue to find ways to address rising costs.

The aging bull market

The S&P 500 and Dow didn’t decline 20% from their highs, which would mark the end of the bull market and the beginning of a bear market. But small- and mid-cap U.S. stocks, emerging-market stocks and the Nasdaq are in bear markets because their prices fell more than 20%. We think the pullback in stock prices has created opportunities because the outlook and the fundamentals are positive and lower expectations may extend the late stages of this bull market. The S&P 500 has dropped by 14% on average during past calendar years, since corrections rarely stop with a 10% decline, and it has rebounded to positive returns by the end of the year in about four or five years.1 Although the recent sharp moves may make this time seem different, in many ways, this pullback looks like many in the past.

Action for investors

If these bigger swings are making you nervous, this would be a good time to check in with your financial advisor. Review your risk tolerance and whether your goals have changed – when markets are volatile, it’s important to stay focused on what matters to you and not daily market moves. Knowing your portfolio is prepared for higher volatility with an appropriate mix of equities and fixed income can help you stay invested when it occurs. Your financial advisor can partner with you to help ensure you’re still on track toward your long-term goals, using a consistent process to help you make portfolio adjustments if needed, including adding more attractively priced investments.

The recent pullback improved valuations, with the S&P 500 trading at about 15 times 2019 earnings, well below its five-year average, indicating that stocks are no longer expensive. Small- and mid-cap stocks were down more than 20% from their recent highs in December and, as a result, are even more attractively valued compared to large-cap U.S. stocks. And we recommend adding international stocks, which outperformed during the fourth quarter after lagging U.S. stocks in the first three quarters of 2018.2 Any improvement in trade tensions and overly pessimistic international expectations could be a positive catalyst.

Important Information:

1 Past performance is not a guarantee of what will happen in the future.

2 Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal. Small- and mid-cap stocks tend to be more volatile than large company stocks. Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

This information is for educational and illustrative purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation.

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