Stock markets worldwide took a sharp drop today. The S&P 500 fell 4% on the heels of a similar-sized decline last week, erasing 2018’s gains entirely. We are back where we were on New Year’s Eve. It was the worst single-day performance in almost seven years.
After a remarkably long stretch of market appreciation with almost no volatility—the better part of the last two years—the declines of the past few days will no doubt come as a shock to the system for many investors. However, from our perspective the plunge in some ways reflects a return to normalcy.
Stocks have higher long-term expected returns than bonds and cash, but it’s never been a free lunch. Stocks can be volatile; their higher returns are the compensation investors expect for enduring a sometimes bumpy ride. And indeed stocks have rewarded investors handsomely over the long-term. Still, 2017’s nearly uninterrupted climb was abnormal and, as noted in our quarterly letter last month, could easily have lulled some stock investors into a false sense of security.
Financial pundits, of course, must find explanations for the recent nosedive, just as they rationalized boundless optimism only two weeks ago. We don’t envy their job. The proximate cause of the big declines today and Friday was the release of positive employment and wage data late last week. Good economic news paradoxically is sometimes bad news for markets. In this case, the news may mean more and faster short-term rate hikes by the Fed, as well as the potential for higher inflation that pushes up longer term interest rates. Higher bond yields provide more competition for stocks and eventually could also temper economic growth.
The nature of today’s drop—a sharp descent concentrated in the last two hours of trading—suggests a selling frenzy not directly connected to any major new information, but instead driven by some combination of automated computer trading and emotional reaction triggered by the previous declines. Last week’s economic news notwithstanding, we see no fundamental factors that would dictate a big change in the investment landscape. Underlying economic indicators remain strong, making it entirely possible that stock prices had simply moved up too far, too fast. In that case, letting some air out of the balloon now may help avoid a more severe correction down the road.
The decline of the past several days may have further to run; no one can say for sure. On these occasions, we remind clients that their time horizons are measured in years and often decades. The key to reaching long-term goals is discipline—sticking with the long-term game plan, rebalancing portfolios when necessary, and keeping an even keel in an ever-changing world. Our job is to help you do just that. If you find rough financial seas disturbing your peace of mind, please give us a call. We’re here for you.