After 2017 ended as one of the best years in memory, 2018 began with the best January stock market gains investors had experienced in 30 years.
Although bonds were beginning to decline, investors’ enthusiasm for stocks was palpable. The market rally was gaining steam. And then it ended. After one of the calmest years in stock market history and a string of records to start 2018, the declines came with a vengeance and volatility returned; at least for one week, and maybe more. Was this a temporary setback or the beginning of something more significant? Only time will tell.
Does anybody really know what time it is? Does anybody really care?
Although inexperienced investors are free to question why the markets go up and down and when, experienced investors know better than to attempt to ascertain what will happen on any given day, in any given week, any given month or any given quarter. Experience teaches us that markets go up and down over long periods of time based on what we call the fundamentals.
The most important of these fundamentals are the level and direction of corporate profits and the level and direction of long-term interest rates. If expectations change for either or both of these fundamentals, you should expect something to happen to stocks, bonds or both.
Experienced investors also know that although over long periods of time stocks rise, they periodically succumb to major adjustments referred to as corrections and bear markets. Corrections are 10 percent declines and they periodically occur every one or two years. Bear markets are 20 percent or greater declines that on average occur every three or four.
Where we find
It is a mistake to assume that because a correction or bear market hasn’t happened in a while, it will happen just because its time has come. Coincident to the declines that started the last week of January was the fact that it had been two years since the last correction.
As of this writing, it is too soon to determine whether these declines will become a correction or whether they will take us into bear market territory for the first time in over eight years.
What we do know is that economic and earnings fundamentals that drove stocks higher last year remain intact. What has changed, however, is that long term interest rates have finally begun to move higher.
The move has come quickly on the back of worries about higher borrowing costs for the federal government, the reduction of economic stimulus that has been provided by central banks around the world, and the possibility that inflation will rise so quickly that our Federal Reserve will have to raise short-term interest rates more rapidly than previously anticipated.
Although time will definitely tell what will happen in the future, even if stocks move into correction or bear market territory, I believe stocks will, over time move significantly higher. Nothing has fundamentally happened to cause a major change in economic or market direction.
As usual, my advice remains for investors to maintain their focus and discipline and to stay invested in well-diversified balanced portfolios.