The markets took a BIG dip in February and have continued to trade in volatile fashion. It’s disconcerting to see the Dow drop 1,000+ points in a day, but it’s happened twice during this correction. In the bigger scheme, we have not seen a normal correction in this market for two years and when you go that long without a correction, the dips tend to be more volatile. So, what caused this corrective phase? There are a couple focal points in the market today.
How aggressively will the Federal Reserve (FED) have to raise rates? – The economic cycle really is an intertwined web. The great news is that the global economies are on the upswing. We have not seen economic activity this strong since 2006-2007. The bad news is that stronger economic activity can lead to inflation. We are already seeing inflation in many parts of the world and, if wage pressures are any indication, we will soon see it pick up in the US. The primary way for the FED to curb inflation is by raising interest rates. Therefore, the million dollar question is how far and how fast will the FED have to raise rates? Only time will tell.
Will the tax cuts spur more growth, or increase the deficit? – There are a couple ways a tax cut can go. If the tax cut does not spur more growth, then it’s simply reduced the amount of revenue it takes in. The gamble with any tax cut is that it will generate more activity and, even though tax rates are lower, the cut will generate more overall revenue to the government because there is a bigger pie to tax. Again, only time will tell.
This economic growth cycle has legs, but that does not necessarily mean we won’t continue to go through this corrective phase for a period longer. That being said, a normal correction in this time frame is healthy and one we expect to last a bit longer.
Anyone else getting a bit seasick watching the market making these huge swings over the last month? In reality, we have not experienced a “normal” correction in over two years, so this correction was not unexpected. The bigger problem is that extended periods of time with low-to-no volatility in the markets tend to reverse to much higher volatility and that’s what we are experiencing today. The ironic part of this drawdown is that it’s being driven by a global economy that is much stronger than most expected.
Along these lines, there are a couple of themes we think bear watching as we move forward in 2018:
How quickly does inflation return? – The US economy was one of the few global economies that grew consistently from 2010 to 2016. When there’s low global demand for goods and services because of a stagnant economy, inflation remains low. Couple the slow growth with the money the FED pumped into the banks, and inflation was kept artificially low for an extended period of time. However, last year marked a significant turn. The global economies have now lifted, in unison, and that has created a very real threat of renewed inflation.
Will the rates continue to rise? – The answer is “yes”. As inflation picks up, the FED could have to raise rates faster than they would like and that’s what has the equity markets spooked. The FED would ideally like to raise rates slowly. But, if inflation accelerates, they will have to be much more aggressive, hence the knee-jerk in the market.
It’s a real “good news/bad news” scenario right now. If the economy grows strongly, rates will go up. Eventually, this could hurt global growth. For now, we believe this corrective phase will eventually give way to higher prices later in the year. But, we also expect the markets to be more volatile than they have been over the last couple of years.
As mentioned in previous communication, we have generally raised our cash positions. We are monitoring potential trending opportunity to reinvest those monies.