It looks like the market pullback/correction we have been waiting for has finally come. We expected it before the end of 2017, but after the republican’s passed their tax reform bill at the end of 2017, we thought the correction could be pushed down the road six months to a year. The triggers that appear to have brought the correction earlier have been rising interest rates during the last two weeks and higher inflation caused mainly by wage inflation. These triggers suggest the Fed will again raise interest rates this year. Investors fear that rising inflation, wages and interest rates will eat into corporate profit. With the markets at elevated levels, any concern to corporate profits is a worry.
We continue to believe we are in a secular or long-term bull market. Pullbacks are healthy and normal during these bull markets. This one was long overdue. We had low volatility in 2017. We suspect that the sharp decline that occurred on Monday may have been due to sell-stops and option contracts being triggered. Further declines, if any, may be smoother.
We have been expecting about a 10% to 15% correction in the markets. As of Monday, the S&P 500 was down about 7.75% from its high for 2018. In the last 38 years, the S&P 500 has had an intra-year drop of about 13.8% (source: FactSet, Standard & Poor’s and J.P. Morgan Asset Management). So, a 10% to 15% correction would be average. History would suggest that since the markets have climbed so fast over the last 15 months, the correction could be more than 15%.
However, remember that we focus on asset allocation, diversifying globally and creating the appropriate mix of stocks and bonds for your portfolio based on your risk tolerance. This means that your portfolio may go down, but not as much as the domestic stock indexes.
We believe the correct approach is to hold tight and not panic. For longer term investors the correction will end and then we believe the upward trend will bring your account to the highs you have experienced as the secular bull market continues. The economy is strong and with tax reform corporate earnings are still climbing despite all challenges. It appears 2018 will have more volatility but the secular bull market could run for another 5 to 10 years.
Please reach out to us if you have any questions or concerns. We can discuss your situation and answer any questions.