Until early 2018, stocks were enjoying their longest period without a five percent pullback in nearly 90 years.1 But in early February, that calm came to a sudden and decisive end, as the Standard & Poor’s 500 Index fell more than six percent during the first three trading days of the month.2
The sudden return of volatility has been attributed to a range of factors. Here are four factors to consider:
1. Inflation Fears - Inflation is a rise in overall prices, which reduces the purchasing value of money. Yield on the 10-year Treasury bond spiked up in February, hitting its highest level in four years.3,4 While higher yields are not necessarily bad for stock prices, they do represent competition for investors’ dollars. In other words, some investors may be tempted to pull money out of stocks to invest in bonds instead.
2. Algorithmic Trading - Algorithmic trading is a type of investment involving certain triggers to buy or sell stocks, using computers to make large trades very quickly. It has been estimated that algorithmic trading is responsible for about half of all the daily activity in the S&P 500 Index.5 The triggers for “pushing the button“ on buy or sell programs can be many, but market watchers say some sell programs were activated when 10-year Treasury yield approached 3 percent.6 This may have triggered other automated strategies, which accelerated the downward move and contributed to the market’s subsequent rally.
3. End of Easy Money - The drop in prices also may be tied to the end of monetary easing. The U.S. Federal Reserve (along with other major global central banks) pursued a policy of low interest rates through quantitative easing in recent years. Quantitative easing occurs when central banks work to lower interest rates in an attempt to spur economic growth. While the Federal Reserve announced the end of quantitative easing last fall, the markets may just be feeling the ramifications of the end of the stimulus program.7
4. Natural Market Cycles - Market corrections are a natural part of the investing cycle. Since the end of World War II, there have been 76 corrections of 5 to 10 percent, 26 pullbacks of 10 to 20 percent, eight retreats of 20 to 40 percent and three draw downs greater than 40 percent.8 A long-range view can be comforting, as you remember that fluctuations have happened many times before.
My final thoughts are this: Market movements are impossible to predict, though continued volatility is likely. Your investment portfolio should reflect your goals, time horizon and risk tolerance. Now is a great time to remember why you invested, stay the course, and avoid overreactions!
1. CNBC.com, January 29, 2018
2. Stocks are represented by the S&P 500 Composite index, which is an unmanaged index that is considered representative of the overall U.S. stock market. Index performance is not indicative of the past performance of a particular investment. Past performance does not guarantee future results. Individuals cannot invest directly in an index. The return and principal value of stock prices will fluctuate as market conditions change. And shares, when sold, may be worth more or less than their original cost.
3. The market value of a bond will fluctuate with changes in interest rates. As rates rise, the value of existing bonds typically falls. If an investor sells a bond before maturity, it may be worth more or less that the initial purchase price. By holding a bond to maturity an investor will receive the interest payments due plus your original principal, barring default by the issuer. Investments seeking to achieve higher yields also involve a higher degree of risk.
4. The Wall Street Journal, February 8, 2018
5. BBC.com, February 6, 2018
6. BBC.com, February 6, 2018
7. Reuters, September 19, 2017
8. U.S. News & World Report, February 5, 2018
* The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation.