After a very strong start to the year (U.S. stocks were up around 7 percent through January 26th), the markets have become somewhat volatile this week. Monday, Tuesday and Friday all experienced large point declines on the Dow and S&P 500, although the percentage declines were only enough to wipe out one-half of the gains generated in January. Having said that, this week will likely be the worst one for stocks in about two years.
Market-driven interest rates (as measured by the 10-year Treasury) have shot up from 2.4 percent at the beginning of 2018 to about 2.85 percent, which is the highest level reached in four years. This is a pretty big move in a short period of time. Generally speaking, a spike in interest rates has a temporarily negative impact on stocks and bonds. With the job market continuing to show strength (88 straight months of positive job growth) and economic growth picking up, the markets are preparing for potential inflation, which could cause the Federal Reserve-controlled short-term interest rates to go up more quickly than planned.
A couple of things are worth mentioning: (1) A large point decline in the Dow will garner significant headlines, but the magnitude must be put in the context of current market values (i.e. a 500-point decline when the Dow is trading around 26,000 is not as significant as a 500-point decline when the Dow was around 15,000); and (2) The U.S. stock market is coming off of 15 straight months of gains, which has never happened before in the history of the markets. A pull-back in this price momentum was inevitable.
Valuations are higher than they were several years ago; however, they are not at extremely elevated levels that usually lead to bear markets. Corporate profits, and the economy in general, continue to show acceleration, and there remains a large amount of cash on the sidelines that could find its way into the market if the sell-off continues. While weeks like this one are no fun to experience, it is a good reminder that investing is for the long term, and the reason that stocks outperform bonds and cash is that investors must be patient and resist the urge to do something that may be detrimental to their goals. No one can say with certainty whether this is just an isolated bad week or if it will continue for a while longer. We will stay on top of market volatility, changes in economic indicators and other potential risk factors, and we will send out periodic updates as needed.