Recent market moves have undoubtedly shaken investors. Equally, however, they have reinvigorated bystanders – the investors standing on the sidelines waiting for buying opportunities. If I had to pick a side, I’d go with the latter. After all, the sell-off has not changed my views on positive fundamentals, but it has made risk asset valuations more attractive. Nonetheless, bouts of volatility like the one we have just seen will severely test investors’ resolve. Here are five lessons to keep in mind:
- Corrections are inevitable, and this one was long overdue: Market calm had been unprecedented. On average, the S&P Index has experienced a 5% drop every 90 or so days. Until last week, more than 400 days had passed since the S&P’s last 5% slump – the longest period since 1929. Borrowing the phrase usually reserved for internet-based travel deals, “If it feels too good to be true, it probably is.” It is worth noting that typically a correction that takes place against a backdrop of strong macro fundamentals tends to be short-lived.
- Changes in monetary regimes are unsettling: Markets have become accustomed to ultra-accommodative central banks. But this is changing. As global growths steams ahead, central banks are becoming more concerned about inflation. Shrinking balance sheets and rising interest rates will inevitably weigh on investor sentiment. Furthermore, with monetary policy being normalized, market dynamics – including volatility and duration of market cycles – are likely to normalize too.
- Periodic set-backs during late-cycle stages are likely: As is the way of late-cycle stages, valuations across risk assets have become very stretched and are vulnerable to a worsening growth/inflation mix. Tentative signs of inflation are now emerging – not least, last week’s fateful U.S. labor market data, which showed average hourly earnings rising at their fastest annual pace since 2009. Markets responded by re-pricing their Federal Reserve rate expectations, triggering a sharp rise in bond yields and derailing equity markets. Yet, as long as recession risk is low, a setback should be all it is.
- Technical market moves can hurt: Although the origins of the sell-off were rooted in concerns about rising inflation and the re-pricing of central bank expectations, the magnitude of Monday’s sell-off was almost entirely fueled by the unwinding of a crowded volatility-related trade. The repercussions of that unwinding include a several billion-dollar loss for investors, many of whom likely had not fully understood the complexities of the product.
- Don’t forget the fundamentals: Equity markets may have tumbled, but that has not affected the underlying strength of the economy. The United States is still in the midst of a very strong earnings seasons, corporate tax reform will provide a further positive catalyst, and global growth is strong. In addition, given the deflationary fears of yesteryear, central banks will remain behind the curve, not ahead of it. Further gains in risk assets are likely, so treat this market episode as a buying opportunity.
Unless otherwise noted, the information in this document has been derived from sources believed to be accurate as of February 2018. Information derived from sources other than Principal Global Investors or its affiliates is believed to be reliable; however, we do not independently verify or guarantee its accuracy or validity. Past performance is not necessarily indicative or a guarantee of future performance and should not be relied upon to make an investment decision.
The information in this document contains general information only on investment matters. It does not take account of any investor’s investment objectives, particular needs or financial situation and should not be construed as specific investment advice, an opinion or recommendation or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding a particular investment or the markets in general. All expressions of opinion and predictions in this document are subject to change without notice. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, nor an indication that Principal Global Investors or its affiliates has recommended a specific security for any client account.
Principal Financial Group, Inc., Its affiliates, and its officers, directors, employees, agents, disclaim any express or implied warranty of reliability or accuracy (including by reason of negligence) arising out of any for error or omission in this document or in the information or data provided in this document.
Third party content, such as comments to this blog, is not reviewed by Principal Global Investors before it is displayed, although we may remove, alter, edit or adapt any such comments. Principal Global Investors does not endorse, authorize, or sponsor any third party content. Links contained in some blog posts may take you to third-party sites and Principal Global Investors makes no guarantees to the accuracy of the information provided
Investing involves risk, including possible loss of principal.
Insurance products and plan administrative services provided through Principal Life Insurance Co. Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc. Securities offered through Principal Securities, Inc., 800-547-7754, Member SIPC and/or independent broker/dealers. Principal Life, Principal Funds Distributor, Inc. and Principal Securities are members of the Principal Financial Group®, Des Moines, IA 50392.