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For the first time in 18 months, stock markets are experiencing a correction.  In 2017, record low volatility dominated markets.  Not once was there a 3% pullback in US stocks.  This complacency has been replaced by panic over the past several trading days.  A popular investor fear measure, the VIX, has spiked from record lows to levels not seen since August of 2015.

The backdrop today is materially different from the one in mid-2015.  Back then, China and Europe were a mess, oil prices were plummeting and globally corporate earnings were in a recession.  Now the US economy is growing.  Recent tax cuts will add to this growth.  Europe is recovering and emerging market economies are in the best shape in years.     Corporate earnings growth remains healthy.  We still believe the fundamentals are intact and are not making any significant portfolio changes.

So, what is causing the sell-off?  It is not one item but several cross-currents hitting at once:

  • Investors had become too complacent.    Markets piled up gains as investors celebrated good news.  The overshoot to the upside is now being worked off.
  • Bond yields spiked earlier this year.  Volatility in one asset class usually spreads and now is hitting riskier assets like commodities and stocks.
  • Certain portfolio strategies, mainly those being driven by computer-based models, are being unwound.  Without getting into the weeds, these strategies were betting on the continuation of low volatility and rising asset prices.  As volatility spiked and asset prices declined, these strategies are forced to sell.  The markets have been overwhelmed with the reversal of these strategies and liquidity has disappeared.  This in turn has magnified price declines.

Let’s keep this decline in context.  US stocks are down less than 1% year to date. This is after 2017 where US stocks were up nearly 20% (S&P 500).  Corrections are normal – last year was not.  On average stocks pull back nearly 14% during the year.  See the chart below from JP Morgan Asset Management that illustrates stock market corrections.

In addition, other asset classes like bonds, historically have helped buffet the downside.  We have also included a chart from Fidelity Investments that highlights that when stocks fall bonds help stabilize the portfolio.  One of our core themes has been expect volatility to return to markets.  Because of this, we wanted to have some defense in the portfolio.  Several tactical managers had become more cautions and have been patiently sitting on cash to take advantage of opportunities.

Lastly, remember the media’s job is to sell advertising not manage your portfolio.  If you are nervous about the markets, please reach out to us.

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Jon Giordani is Chief Investment Officer for PSG.  He provides innovative investment planning strategies to our clients.