“…nothing truly eventful has happened yet.” – Nir Kaissar
Less than a month ago our post Slowmentum profiled the complete lack of volatility present in the stock market throughout 2017. At that point the market was only days away from blowing through the record for consecutive trading days without a 5%+ correction. The streak did in fact extend past the previous mark to a new record of 404 trading days before being stopped in its tracks by the recent global sell off.
They say that bulls climb stairs and bears jump out the window. That description certainly seems apropos for what we’ve just witnessed. After over a year of some of the smoothest sailing ever seen in stocks a swift and violent correction snatched away the market’s year-to-date gains, and as we write this Insight global stock markets are off 7-8% from recent record highs.
Despite the eye-popping moves on Friday and then Monday, we don’t see the pullback as that worrisome. Yes, it’s the worst bout of volatility we’ve seen for a number of years, but remember that the past year or two have been some of the most uneventful on record. If anything, we’d say the previous lack of volatility is really much more unusual than what we’ve seen over the past few trading days. The table below, from JP Morgan Asset Management, reflects the annual returns for the S&P 500 in the vertical gray bars contrasted with intra year declines in the red dots below. As you can see, intra year declines in the 5-15% range are not at all uncommon for the market, even in big up years.
Additionally, we don’t see the primary causes of the selloff as that concerning. It’s a classic “good news is bad news” story, where surprisingly strong economic data finally seems to be working its way into inflationary pressures (primarily higher wage growth). In turn, bonds have sold off as yields and interest rate expectations have spiked. The underlying trends are positive, and we think abandoning risk assets in anticipation of tighter future monetary conditions would be premature.
Perhaps the most interesting nuance seen in how the market sold off has to do with the role of machines rather than deliberate selling decisions made by human beings. Morgan Stanley hints at this in a research note from yesterday,
Today’s move appeared to be an extension of the sell-off that began last week. While the market opened slightly lower, the move accelerated once the S&P 500 crossed its 50-day moving average – a technical level that has been closely watched by the market over the past year.
We’ve read several pieces that have suggested that the 50-day moving average served as the equivalent of a digital “SELL!” order for automated trading systems worldwide, triggering a brief selling frenzy mid-day that exacerbated the market’s decline. We’re not sure how valid these speculations are, or even how to try to quantify them, but the role of computers in today’s markets is certainly making these large down days more interesting.
In summary the market has spent the year drawing in its breath, and a good Exhale was long overdue. We don’t pretend to know whether or not the past handful of days portend more pain to come, or if it will serve as a good slap in the face for market participants lulled half asleep by the last two years of low volatility. But our guess would be it turns out to be the latter. Given the fact that our trend following discipline is more intermediate-term in nature, we will remain fully invested to our targets in stocks unless the weakness continues to persist.
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
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