The Market Corner: The Month in Review "It’s the market Baby!"

By Filippo Lecchini

It’s the market Baby!

February brought the return of volatility that many have been predicting for quite some time. Too early to say if this is a correction or an isolated episode. And truth be told the market already shed over 8% from all-time high, which is not “officially” a correction, “at least 10%”, but is pretty close.

As usual there is all sort of speculation around big market moves but every guess is just as good as any other. Complacency, profit taking, technical reversal, animal spirits and all the usual nomenclature applies.

Timing the market is a fool’s errand but while getting comfortable with short term swings is just part of every investor’s life, in the long term the economic fundamentals should at least play a role.

The US and the World Economy are growing. US Growth is pretty much in line so far with the previous years. Tax reform could further contribute to expanding economic activity, but large corporations and public companies are probably not going to benefit as much and as uniformly from the cuts as small business will. Obviously more growth would be welcomed by everyone so that is hardly a concern, but if that is the outcome there are different ways to attain it. With unemployment close to the natural rate, i.e. very low, and sustained growth the concern is that the tax stimulus, particularly if a large infrastructure plan were to be approved alongside it would lead the economy to overheat which is another way to say inflation could become an issue. Raising prices would not be the only concern because the FED, already shifting to a more hawkish outlook after years of Quantitative Easing, could be inclined to intervene more quickly and forcefully.

Monetary policy is a complicated balancing act where the effects of a decision do not manifest for several months, if not years, but can affect expectations immediately. Curbing the growth’s pace just enough to prevent inflation in a nutshell is the nature of the exercise when the economy is healthy, and equities are rising. Even though all this might appear reasonable however, the unpleasant implication is that higher interest rates will make cash and fixed income products more attractive in comparison to equities, possibly causing an outflow. This so far seems to be the more popular explanation for the early February selloffs.

Other aspects that can influence market action are of course politics, domestic or international, natural disasters and all sort of unforeseeable circumstances. Most of that is not predictable but what is interesting to note is that depending on timing the reaction could be very different. Is human nature to be jumpy when rattled as opposed to confident when things are good.

Lastly, it is worth thinking about what a correction practically means for investors. Is it necessarily a bad thing? The answer as always is “depends”. During the financial crisis every bit of a rally made everyone feeling better as the sequence of seemingly catastrophic news never appeared to cease. But what about today, where the state of the economy is not a concern? While some people just have a hard time dealing with losses, many investors will welcome reasonable selloff as an opportunity to reprice risk when the markets seems to have gotten ahead of themselves. For those who can keep cool and maintain a long-term view buying opportunities could be within reach.
At the time of writing equities rallied 2% after two brutal sessions. Nobody knows what the near future holds but there is a consensus expectation that the markets will finish the year higher. For the time being, all we can say is that volatility is back and is not that bad.

Looking ahead:

 A new Chairman of the Board took over at the Federal Reserve that meets next on March 20-21. In the meantime, another possible shutdown is looming and that at some point needs a more exhaustive solution than a quick backstop.

Finally hope: when a NFC team wins the Super Bowl the market rallies for the rest of the year, when an AFC team wins the market goes down. The prediction came true in 40 of the past 51 year when a Superb Bowl was played, last year a noticeable exception. The victory of the Philadelphia Eagles, an NFC team, should then be received as a good omen for investors.
 

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