Investment Insights: Take a deep breath

Wade Balliet
Posted by Wade Balliet
Investment Strategy

This weekly report presents insights from our Global Investment Management team.

Two concerned stock traders - man and a woman - staring at a monitor.A pullback that many investors and market participants have been expecting, including the Bank of the West Global Investment Management Team, seems to have partly unfolded in recent weeks.

The S&P 500 has dropped over 6% in the last two trading days after grasping an all-time high of 2,873 on January 26, and stock markets around the world are reacting similarly. The impromptu decline has already erased the entirety of 2018 gains for the S&P 500 after investors enjoyed a return of 7.55% in the first 26 days of the year. Despite continued strengthening in corporate earnings, stocks seem to be responding to recent employment data that pointed toward increased inflation and a rapid upward move in bond yields, which could spur action from the Federal Reserve. This has left many investors asking: What’s going on and how should I react, if at all?

A particularly strong employment number released on Friday appeared to be the spark for the selloff as investors grew more concerned over rising inflation, which would likely force the Fed to raise rates at a notably faster pace than anticipated. Bond yields added fuel to the fire as their upward pace moved from a casual walk to more of a sprint. The 10-year Treasury yield had hurtled up almost half a percent since the beginning of the year and touched 2.84% last week before falling to 2.71% today as investors seek the safety of bonds amid the rout in equities. Just a month ago, markets were focused on a potential inversion in the yield curve, but have now become fixated on long-term rates rapidly rising. It seems as though Goldilocks can’t find that “just right” temperature and has thrown out her porridge along with the kitchen sink!

Even as stocks pull back, corporate earnings and strong global growth continue to be a bright spot for investors and may be the support needed to stem the decline. According to data aggregation by Bloomberg, so far earnings this quarter have grown almost 15% and are beating estimates by an average of 3.48% – showing particularly strong improvement over previous periods. The synchronized global recovery has picked up steam in recent months, and global economic data is showing marked improvement. Positive GDP growth in major developed and emerging markets is expected this year, and large fundamental economic drivers continue to remain in expansionary territory. Although valuations have crept higher and markets have become a bit too exuberant, a heavy dose of reality has been combined with a minor break in optimism and has caused a break in the trend. According to Bloomberg, the markets haven’t seen a 5% correction in about 19 months, going back to June of 2016, suggesting that this healthy pullback may have been well overdue, in our opinion.

First and foremost, investors should stick to their long-term investment plan with the expectation that these types of market events will happen over time. Disciplined investing should be just that, disciplined. Large shifts in allocations in reaction to short-term market fluctuations ought to be discouraged, in our view. While news outlets may sensationalize the decline in major stock indices as well as the deepening cryptocurrency backlash, we believe this is simply a bump in the road. Our team continues to believe stock markets will move modestly upward this year based on strong earnings reports and solid economic footing from substantial tax cuts and improving global growth. It has been our expectation that volatility would increase back to more normalized levels versus the benign levels we had seen in recent years. We believe it is important to keep a steady focus and long-term perspective as volatility returns to the market, but we are prepared to make tactical shifts in our strategies.

Chart showing various market returns as of 2/5/18
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Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

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