By February 8, stocks had fallen more than 10 percent from their January highs, leaving many investors to wonder how things could change so fast. Days later, sentiment had shifted yet again and stocks trended higher.3
The sudden return of volatility has been attributed to a range of factors. Here are four to consider.
1. Inflation Fears
The January employment report (released on February 2nd) showed an increase in long-stagnant wage growth, creating fears of accelerating inflation and higher interest rates.4Inflation is a rise in overall prices, which reduces the purchasing value of money.
Amplifying the economic issues was concern over American fiscal policy. The recent tax cuts have sparked worries that the “fiscal stimulus“ may prove inflationary, which also may put upward pressure on interest rates.
Yield on the 10-year Treasury bond spiked to 2.88 percent on February 8, hitting its highest level in four years.5,6 While higher yields are not necessarily bad for stock prices, they do represent competition for investors’ dollars. In other words, some investors may be tempted to pull money out of stocks to invest in bonds.
2. Algorithmic Trading
Algorithmic trading is a type of investment involving certain triggers to buy or sell stocks, using computers to make large trades very quickly. It has been estimated that algorithmic trading is responsible for about half of all the daily activity in the S&P 500 Index.7
The triggers for “pushing the button“ on buy or sell programs can be many, but market watchers say some sell programs were activated when 10-year Treasury yield approached 3 percent.8 This may have triggered other automated strategies, which accelerated the downward move and contributed to the market’s subsequent rally.
3. The End of Easy Money
The drop in prices also may be tied to the end of monetary easing. The U.S. Federal Reserve (along with other major global central banks) pursued a policy of low interest rates through quantitative easing in recent years. Quantitative easing occurs when central banks work to lower interest rates in an attempt to spur economic growth. While the Federal Reserve announced the end of quantitative easing last fall, the markets may just be feeling the ramifications of the end of the stimulus program.9
4. Natural Market Cycles
Market corrections are a natural part of the investing cycle. Since the end of World War II, there have been 76 corrections of 5 to 10 percent, 26 pullbacks of 10 to 20 percent, eight retreats of 20 to 40 percent and three drawdowns greater than 40 percent.10 A long-range view can be comforting, as you remember that fluctuations have happened many times before.
Market movements in coming weeks are impossible to predict, though continued volatility is likely. Your investment portfolio should reflect your goals, time horizon and risk tolerance. Now is a great time to remember why you invested, stay the course, and avoid overreactions.