Cannon & Co

After months of warnings from Wall Street that the markets’ extraordinarily long bull run could not last forever, the inevitable happened. Volatility returned to U.S. markets in a major way in February. The precipitous falls that happened on Feb. 2 and 5 were all the more shocking to investors because the market trend for many months had been almost consistently upward.

Investors got over their initial shock, and the decline became much less scary when investors calculated that the staggering 1,175 drop in the Dow Joes Industrial Average (DJIA) on Feb. 5 – although the biggest drop ever in absolute terms – had only taken share prices back to their starting point at the beginning of 2018. The incredible upswing since Jan. 1 had taken the DJIA so high in such a short amount of time, that this seeming correction in February in fact represented a decline in value of only 4.6 percent. This all being said, the return of volatility in the U.S. markets had a sobering effect on stocks worldwide during the first week of February. In London, the Financial Times Stock Exchange (FTSE) 100 fell 8.2 percent from its record high in January, and the MSCI Emerging Markets Index dropped by 7.5 percent. An element of calm was restored to international markets when the Dow rebounded quickly following its alarming decline, but major U.S. stock indices continued to gyrate throughout the month, logging gains only to give them up a day or so later.

What is Fueling the Turbulence?

Many analysts have suggested that uncertainty over interest rates is a major factor. Both the Federal Reserve Bank in the United States and the Bank of England have begun to increase interest rates and curtail their respective “quantitative easing” policies. Monetary policy going forward is less certain. In the United States, the Fed has undergone a change of leadership as Janet Yellen has departed and Trump appointee Jerome Powell assumes the role of chairman. Nervous speculation regarding monetary policy was fueled when the minutes from the January 2018 Federal Open Market Committee meeting were released in late February. Many who reviewed those minutes felt they indicated a more hawkish approach to monetary policy. Some economists also have voiced concern over possible increases in inflation rates in response to global economic growth. These concerns seem to be as yet unfounded, with core inflation in the United States (excluding food and energy) at 1.5 percent.

Positive News

Many Wall Street analysts remain optimistic and see February’s market turbulence as a temporary hiccup. Leading economic indicators suggest that economic growth in the United States will be strong in the first half of 2018. They note that fourth quarter earnings for 2017 have been good, with the Standard & Poor (S&P) 500 Index showing profits up by 13 percent and sales up 8 percent over last year. They believe the corporate tax cuts also will help boost profits, and that shareholders will benefit from cash-rich corporations buying back shares.

It remains to be seen whether they are right and that the recent market turbulence was a short-term reaction to monetary policy concerns, or if February’s gyrations were a precursor of more volatility to come.

The observations above are general commentary and are not intended to replace the advice of your professional investment and tax advisors.