Is 2018’s Market Volatility Normal?
By Tim Courtney, Chief Investment Officer
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After about a year and a half of fairly steady gains in the stock market, the script has changed in 2018. The S&P 500 Total Return Index1 has experienced two corrections of 10 percent in the last year (one in February and one in October). The index is, as of Nov. 7, still down 2 percent from the high reached in January.
Other markets have been even more volatile. Smaller companies, as measured by the Russell 2000 Total Return Index, fell more than 15 percent in September and October.2 Developed international companies3, which were outperforming until trade and tariff discussions started, nearly hit bear market territory and were down 19 percent between February’s high and October’s low. Emerging market companies did tip into a bear market and were down 27 percent from peak to trough.3
We haven’t seen these kinds of swings in a while, but this level of volatility is closer to the average we’ve experienced over the last 90 years than what 2017 produced.1 There are several reasons for the increased volatility, but two obvious reasons are the trade and tariff concerns as well as the Fed’s communications regarding interest rates.
What likely kicked off the October decline was investor concern about rising rates. On Oct. 3, Federal Reserve Chairman Jerome Powell indicated that there was still a long way to go before the rate increases would stop.4 The market closed lower over the next six days and fell nearly 7 percent during that time.1
The Fed has a tough job as it tries to move interest rates in a fairly healthy economy back to more normal levels. It probably realized it sent too strong a message and decided this week to keep interest rates unchanged for the time being.
During all of this, companies have gone about their business and continued to work toward increasing their earnings. For the S&P 500, earnings are expected to total close to $140 for 2018, a new record eclipsing 2017’s record of about $110 by a wide margin.5 Much of this is due to the corporate tax reform completed last year and was expected by markets. The markets did very well in 2017 as it frontloaded returns justified by the higher earnings it knew were coming.6
However, not all of the earnings growth is due to the tax law. Some of the growth is a result of the economy performing well and revenues increasing. The most recent estimate for third-quarter growth was 3.5 percent, and sales growth has been running at about 10 percent in 2018.5 This is a marked improvement from the 2013 to 2016 timeframe in which revenues were essentially flat.
2018’s volatility, while elevated, is more normal than what we’ve gotten used to over the last five years. It’s also a sign that investor expectations are higher and that unexpected changes like tariff threats and interest rate increases will move markets more than they would have when prices were lower. Behind all of this market movement though, fundamentals like sales and earnings continue to improve and consumer confidence remains high.7
1. Yahoo! Finance – Vanguard 500 Index Investor (VFINX)
2. Yahoo! Finance – iShares Russell 2000 ETF (IWM)
3. Yahoo! Finance – iShares MSCI EAFE ETF (EFA)
4. CNBC.com – Powell says we’re ‘a long way’ from neutral on interest rates, indicating more hikes are coming
5. S&P Dow Jones Indices – S&P 500®
6. CNN Business – It was an epic year for stocks
7. Reuters – U.S. consumer confidence at 18-year high; house price gains slow
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