What is going on
After a long steady period for stocks, volatility has raised its ugly head, sending equities sharply lower. In the last week, the S&P 500® index has fallen approximately 8% from its high. The decline gained steam on Friday, February 2, with the release of a U.S. Bureau of Labor Statistics (BLS) report revealing that average hourly earnings rose 2.9% year-over-year in January, the largest increase since the end of the recession in 2009. While the absolute magnitude of the rise was not astronomical, it was larger than expected, given that up until this point, the economy had added jobs for 87 consecutive months without a meaningful uptick in wages.
Automated trading may have increased the size of the sell-off despite an absence of poor major economic news. By some estimates, quantitative trading accounts for as much as 90% of market volumes, so the unwinding of short-volatility positions may have increased losses, particularly as the CBOE Volatility Index® (VIX®) jumped from low double-digits to a reading of 50. In addition, the recent synchronization of global growth may have proven a double-edged sword, as investors globally took profits in unison.
Although market declines are not taken lightly, we believe that the fundamentals are still intact. Gross domestic product (GDP) growth remains solid, but not at overheated levels. This recent downturn is a very different event from the market decline in early 2016, when fears of a recession were in play. And while wage inflation bears watching, even labor markets may have some elasticity, as labor-participation rates remain approximately 3.5% below where they stood a decade ago, per the BLS.
Although corrections can make investors' nervous, they can actually be healthy after extended run-ups in market indexes, as they rein in valuations and allow the market to consolidate its gains. We also have seen sudden corrections before, such as when Dow futures fell 800 points overnight following an unexpected Trump victory in the presidential election, only to rebound sharply when the market reopened.
Our Positioning Going Forward
Given the absence of a change in fundamentals, our approach is to stay the course.
It is also possible that recent declines could make certain stocks or sectors more attractive than others. According to FactSet, more than 80% of companies included in the S&P 500 index that have reported fourth-quarter results have beaten analysts’ revenue expectations. While not baked into fourth-quarter 2017 results, it is expected that the tailwinds provided by tax cuts will boost earnings further going forward. Finally, after the recent decline, J.P. Morgan estimates that the S&P 500 index now trades at 16 times forward earnings. We remain constructive on the market as a whole and our managers will continue to look for stocks with relatively attractive earnings and the potential to exceed expectations, while minimizing volatility. With our time segmented portfolios and taking your withdrawals from targeted funds, this too will pass.
The CBOE Volatility Index (VIX) is a key measure of market expectations of near-term volatility conveyed by S&P 500 index stock-option prices.
The S&P 500 index is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the U.S. stock market.
This commentary reflects the views of the Rick Zurbriggen, are based on current market conditions, and are subject to change without notice. These views represent the opinions of Rick Zurbriggen at Zurbriggen Financial and are presented for informational purposes only. These views should not be construed as investment advice, an endorsement of any security, mutual fund, sector, or index, the offer or sale of any investment, or to predict performance of any investment. Any forward-looking statements are not guaranteed. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed.
All investing involves risk, including the possible loss of the principal amount invested.