As we closed last quarter, the S&P 500 (barometer for the U.S. markets) had just reached an all-time high of 2940. Since the peak, the index has fallen 19% while the NASDAQ is off 23% since its high. In recent days, the volatility has intensified for several reasons:
- There is a perception that the Federal Reserve will raise interest rates too fast, hence choking off the economic growth prematurely.
- Investors are forecasting a slowing economy and the increasing possibility of a recession.
- The effect of the current state of global trade relations is starting to be seen in economic numbers and may further disrupt growth.
- Recent turmoil in Washington including a government shutdown and Trump administration staff changes has led to increased market uncertainty.
- Algorithmic trading of ETFs and passive mutual funds has increased both upside and downside volatility.
We believe that the recent correction and subsequent bear market conditions will not result in an impending recession. We continually monitor economic indicators which are not signaling a recession, but rather a slowing economic environment. As seen in the BaR (Baseline and Rate of Change) analysis in the Grid on the right, the current MoC (the mean of the coordinates of 19 key economic indicators – red point in chart) remains in the “expansion” quadrant.
We acknowledge that economic growth is cyclical. As the cycle matures, indicators hit new highs, then stall, then often move upward again. This can result in a number of economic indicators moving into the “decline” quadrant of the Grid and the MoC shifting leftward. However, as long as the MoC and the economic indicators remain above the baseline, the economy is still growing, although at a decreasing rate. In fact, as seen on the Grid, the 2001 and 2007 recessions started with the MoC clearly in the bottom of the “decline” quadrant.
While we recognize that bear markets typically occur concurrent with a recession, they are not always associated with a recession. Since 1950, there have been 14 bear markets of which 5 were not associated with a recession (2016 was the most recent occurrence). Bear markets that occur absent a recession are normally short-lived and tend to be “V” shaped. We believe that the current bear market will also be short-lived. While our analysis is relatively complex, a reversal of any of the reasons for the volatility listed above should give the markets reason to stabilize as the economy continues to expand.
Calling the bottom of a correction is unlikely to be successful but absent a deterioration of the current economic conditions, we are still constructive on the markets for 2019 and believe our investment strategies will offer opportunities. As the current economic and political environment continues to develop, volatility should remain elevated. However, we believe that prudent diversification will afford our clients the opportunity for growth in 2019 as the economic expansion continues.
We encourage you to contact your portfolio manager to discuss any concerns that you may have regarding your investments.
Jon is Senior Vice President, Director of Fixed Income and Investment Strategy at Pennsylvania Trust.
Disclosure: This Commentary represents a review of topics of possible interest to Pennsylvania Trust’s clients and is not personalized investment advice. It contains Pennsylvania Trust’s opinions, which may change following the date of publication. Information obtained from third-party sources is assumed to be reliable but is not guaranteed. No outcome – including performance – is guaranteed, due to various uncertainties and risks. This document is not a recommendation of any particular investment. Investment decisions for clients are made on an individualized basis and may be different from what is expressed here. Past performance is no guarantee of future results.