The Current Market Transition and What It Means To Investors

Written by John Cox, CFA, CAIA on October 16, 2018

“To everything (turn, turn, turn), there is a season (turn, turn, turn).” – these are the lyrics to a popular song by the Byrds in the 1960s, but they are still applicable today.

Coming off a good third quarter in which global stocks returned 4.3%, October has started out to the downside, with markets declining by about 4% so far this month. Last week, there were two days of drops in the Dow Jones that exceeded 500 points. While these declines can be unsettling, they are not unusual when looking at historical market volatility. Even though October is remembered for outlier performance, such as the largest one-day drop in 1987 and the most intense part of the financial crisis in 2008, it has generally been a positive month. Additionally, it sets the stage for what has traditionally been the best period for the markets—November through January.

As we have discussed, investors are getting used to a transition period, which involves higher volatility, higher interest rates and the potential for higher inflation. This environment represents a change in season from a time when each of these factors was much lower. It is natural for there to be anxiety as this occurs. In addition to the transition, investors are dealing with elevated trade tensions between the U.S. and China, as well as uncertainty around mid-term elections. It wasn’t so long ago (late January/early February) when we experienced a two-week period in which markets declined by 10%, causing the first “correction” since 2016. It is true that the 10-Year Treasury has made a fairly large move this year, from 2.4% to around 3.2%, but this has primarily been driven by stronger economic growth, not inflationary pressures. As yields move up, and we approach higher business/consumer loan rates and a 5% 30-year mortgage for the first time in quite a while, economists begin to worry about the housing market and affordability. While these concerns are legitimate, rates would likely have to go much higher to begin to impact behavior and profitability, given almost 10 years of increases in net worth.

On the good news front, the economy and corporate earnings continue to be strong. Unemployment is near a 50-year low. Small business owner optimism is at a multi-decade high, and recent reports have indicated that President Trump and Chinese leader Xi Jinping will meet next month at the G-20 Summit. As long-time investors, we know that markets typically “correct,” with at least one 10% intra-year decline and sometimes more than one in any given year. Warren Buffett is famous for many things, including great quotes. One of our favorites has always been, “I’m buying stocks, but I’m not buying them because I think they’re going to go up next year. I’m buying them because I think they’ll be worth quite a bit more money 10 years or 20 years from now. And I don’t know whether they’re going to go up or down tomorrow, next week, next month or next year.” We believe this is great advice for all investors. If the “Oracle of Omaha” is not trying to time the market, then neither should we. Let time be your friend by ignoring short-term volatility in favor of long-term returns.

*Disclosure

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