Last week, the streak of days during which the S&P 500 never feel more than 3% from an all-time high ended at 202 days in total. 2017 was a very abnormal year in regards to how little downside stock markets experienced. We typically experience a 10% pullback in U.S. stocks at least once a year, so going over a year with nothing more than a 3% pullback is quite remarkable. As we have been saying, we anticipate a more volatile stock market in 2018, not because we have a crystal ball, but that it would simply be ‘normal’.
The chart below highlights how ‘abnormal’ 2017 was in terms of the maximum drawdown denoted by the red dots. As you can see, we regularly experience a maximum drawdown of at least the high single digits, even in years when the stock market finishes positive.
In addition, The US Stock market as measured by the S&P 500, spent a record 108 days above its 50 day moving average. As you can see in the chart below, this is a fairly normal occurrence and the fact that it was 108 days since it last happened was the abnormality.
Some pundits have been drawing comparisons between the performance of the Dow last Friday and Black Monday, the memorable day in 1987 when the index shed 508 points in a single day. Yes, the Dow lost more than 600 points on Friday. That was about 2.5 percent of its value. On Black Monday a lesser drop equated to a 22 percent loss for the Dow. In addition, Black Monday was widely attributed to program trading gone awry. Simply looking at the number of points the market was down and not referencing the relative percentage of the decline, sells newspapers and gets viewers on TV, but does not tell the whole story.
Last week, the U.S. Treasury announced it would begin selling more short-term government bonds to fund the rising budget deficit. That sparked concerns about the impact of a bigger bond supply on interest rates. When bond supply exceeds demand, interest rates typically go up to attract investors. The United States already has ample bond supply since the Federal Reserve curtailed its bond buying program.
Financial Times reported “Equity investing involves a delicate balance of three things: earnings, interest rates and valuation. Over the past decade, low long-term bond yields have played a crucial role in helping elevate equity valuations. News about employment and wage gains added fuel to the fire of investor worries. In January, the United States experienced its strongest wage growth since 2009. While that is good news for workers, it may cause the Fed to raise rates more aggressively in an effort to keep inflation manageable.
The Federal Reserve Bank of New York released their updated recession probabilities last week, which estimates the probability of a recession occurring in the United States within the next twelve months. As you can see, The Federal Reserve Bank of New York had a probability of just over 10% that a recession will occur by February 2019. The key driver of their model, is the spread or difference between, the yield on a 10-year U.S. Government bond and the 90-day Treasury bill. This spread turns from positive to negative, meaning the 90-day Treasury Bill yield is higher than a 10-year U.S. Government bond, prior to the start of most recessions. We are monitoring this relationship, but as of now, this relationship is still positive and not signaling a recession.
Investors should take the opportunity to examine the risk of their portfolios and their own tolerance for volatility. For regular readers, this isn’t new advice. We’ve shared numerous charts showing how low volatility has been, predicting it would move higher, and encouraging readers to prepare for potential downturns.
Having a trusted investment management process and system is key to long-term investment success, as well as, managing the items you can control: your asset allocation, appetite for risk, behavior, savings plan and goals.
Key points for the week
- Markets declined sharply on concerns over inflationary wage growth.
- Even with the decline, 2018 has been a great year thus far for stocks.
- Weeks like these are a normal part of investing.
- Key Quote – It is not the stock market that is being tested, it is investors that are being tested.
Is the VIX Signaling a Bottom?
Last week, the Volatility Index known as the VIX, spiked up in response to the drop in most stock markets. Tom McClellan published an interesting chart on Saturday showing the instances when the current price of the VIX was above all of its futures contracts. Typically, the spot price of most investments will be priced below its future price due to the time and volatility premiums option traders demand for the increased risk. However, there have been several times in years past where this normal relationship flips.
The last time the VIX spot price rose above the future prices was during the November 2016 Presidential election. This spike in the VIX coincided with a short-term bottom in US stock markets and the market, as measured by the S&P 500, has risen approximately
What are we reading?
Below are some areas articles we paid particularly close attention to this week. We encourage our readers to follow the links.
It was good news for America’s workers that put pressure on the markets this week. The United States added 200,000 jobs in January, while holding the unemployment rate at 4.1 percent. Most importantly, wages grew by an annualized rate of 2.9 percent, the greatest wage growth since mid-2009.
The faster rate of wage growth undercut some of the foundational elements that have supported this bull market. After a long recovery, the economy seems to be approaching the level of unemployment where wage and inflationary pressures are building. Wage pressures could reduce high corporate profit margins by raising the cost of labor. Higher inflation would push the Federal Reserve to raise rates more quickly than expected, increasing both the cost of capital and interest expense.
The economic news and recent Fed communication raised the possibility of four rate hikes this year, which is more than the market expected. Economies can tolerate higher wage pressures as long as output-per-worker increases. Unfortunately, economic data this week showed productivity dropped last quarter.
There weren’t a lot of places to hide from this week’s decline. While bonds dropped less than stocks, increased inflation is a risk for both asset classes, and bonds offered little protection from the decline. International stocks did better than U.S. stocks but they also declined.
Looking forward, international markets seem better positioned if wage pressures increase in the United States. Unemployment rates are significantly higher in Europe and faster growth would be less likely to lead to inflation and higher rates.
What Does Success Mean to You?
For some, having a big following on social media translates as success. NASA, which has more followers than any other government organization worldwide (28 million), may be considered successful. Of course, NASA doesn’t hold a candle to Katy Perry, who has close to 106 million followers. It will surprise few to learn the U.S. Treasury, which manages the money resources of the United States, doesn’t have many followers (770,000); however, it has more than the Federal Reserve (446,000).
A corporate survey, Making It in America, queried Americans about what it means to reach a level of success, comfort, and security that you find wholly satisfying; As you might expect, there were a variety of answers. One gauge of success is income, according to about two-thirds of the respondents. The group’s average income was $57,426 a year. They would know they made it when they earned about $147,000 a year. According to CNBC, annual income of $150,000 would put many people in the middle class, depending on where they lived and the size of their households. Its notable few people aspire to join the ranks of the wealthiest Americans. More than three-fourths said they would not want to earn more than one million dollars a year. Of course, money is not the only measure of success. A Pew Research study found just 11 percent of those surveyed thought wealth was an essential part of the American dream. Far more important were:
- Freedom of choice in how to live (77 percent)
- Having a good family life (70 percent)
- Retiring comfortably (60 percent)
- Contributing to their communities (48 percent)
- Owning a home (43 percent)
- Having a successful career (43 percent)
One participant said, “Even though I truly believe that having money is freedom, money is really just a tool to make experiences in life possible.” We agree.
Story of the week
How would you like to make $10,000 in an hour? Well, all you have to do is take Equifax to small claims court. Equifax was responsible for a data breach that gave hackers information, which included social security numbers, to more than 145.5 million people. Unfortunately, you have to prove how you have been affected by the breach. Nevertheless, people are still winning their cases, providing a little justice against the big corporation.
Weekly Focus – Think About It
“You can’t reach for anything new if your hands are still full of yesterday’s junk.”
~ Louise Smith, NASCAR driver
Links & Disclaimers
RJFS and SPC do not offer or provide legal or tax advice. Tax services and analysis are provided by the related firm, S&M through a separate engagement letter with clients. Portions of this newsletter were prepared by Carson Group Coaching. Carson Group Coaching is not affiliated with RJFS, SPC or S&M. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. This information is not intended as a solicitation of an offer to buy, hold or sell any security referred to herein. There is no assurance any of the trends mentioned will continue in the future. Any opinions are those of the author and not necessarily those of RJFS. Any expression of opinion is as of this date and are subject to change without notice.
Opinions expressed are not intended as investment advice or to predict future performance. Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Past performance does not guarantee future results. Investing involves risk, including loss of principal. Consult your financial professional before making any investment decision. Stock investing involves risk including loss of principal. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Please note direct investment in any index is not possible.
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