Even with the portentous headlines amid the recent volatility, Alaska Permanent Capital remains cautiously optimistic. Our team has summarized the current market volatility, placing some context around this short-term decline in stock prices.
Why Alaska Permanent Capital is Cautiously Optimistic Now:
- Global economic data continues to point to a broad economic expansion that began in late 2016.
- Corporate earnings (a fundamental driver of financial markets) are expected to be double digit in both the U.S. and international markets.
What happened on Monday:
Last week a strong employment report and higher than expected wage growth made investors nervous that inflation could rise more quickly than previously expected. This could force policy makers to raise interest rates faster than what is currently priced into the markets.
Currently reported inflation expectations are tame. In fact, wage growth picked up only slightly from 2.7% y/y to 2.9%. We suspect that the magnitude of this selloff could have been exacerbated by automated computerized trading. Although Tuesday was volatile the markets ended the day up almost 2%.
Normal Market Corrections:
On average, the market experiences a 10%+ intra-year correction. This decline may feel particularly disconcerting because realized volatility, up until recently, has been the lowest since 1964. This correction is healthy for two reasons. First, it has reversed the recent trend of investor complacency, preventing the onset of euphoria often associated with stock market bubbles. Secondly, it can help the Fed maintain its current plan for policy normalization, which would be good for the stock and bond markets.
We need to see more signs of higher inflation or softer economic data before we are ready to become defensive. In the short term, markets are not always rational and in today’s world corrections (at least a 10% loss) happen in hours not days. In order for this correction to justify a bear market (20%+ loss) the outlook for the economy and earnings would need to change.
The team at APCM is monitoring high frequency economic and earnings data to see signs that might cause us to change our outlook as we choose an allocation for portfolios. Today, we don’t see the data to support this and we note that healthy wage inflation is good for economic growth. We may be moving out of the exceptionally low volatility environment that we have been experiencing for the last several years, but this should not derail a sound investment strategy. APCM integrates reasonable future volatility projections for portfolio construction and strategic planning purposes.
Of course, it’s worth keeping the recent moves in context. This sell off has only reversed the unsustainable pace of gains that started the year. Markets are still positive year to date. The stock market has delivered a 19% annualized return since the Financial Crisis, expect more modest but, over time, positive returns going forward.
Brandy Niclai, CFA
Chief Investment Officer