Market Commentary - March 2018

In our January Market Commentary we mentioned that the low levels of volatility experienced in 2017 were not likely to continue. Sure enough, volatility spiked from late January into February with the S&P 500 experiencing several 3-4% single day declines and as much as 5-6% intraday moves! February is going to end up as one of the most volatile months in the last decade while 2017 was one of the lowest in the last 60 years.

Rising interest rates is one of the reasons given by many as the culprit of the recent sell off. Historically, however, stocks tend to increase during periods of rising interest rates. Of course it is important to point out this time could be different since we are experiencing rising rates coming out of a period of unprecedented levels of quantitive easing and low rates. But, it is also possible higher rates may simply reflect the rising pace of economic activity. Economic expansion is typcially identified as a catalyst of long-term stock returns. 

I feel interest rates are not the place to look for blame right now.

The area that should be receiving more attention is inflation. Inflation is currently a little over 2% which is still relatively low (at at the targeted number for the Federal Reserve) but has been on the rise since 2015. With the U.S. economy being near full employment along with increased wages (all seemingly "good" things) the added tax "stimulus" could overheat the economy leading to a large spike in inflation which would provide markets a major reason to pull back. Rising inflation tends to lead to an increase in wages and production costs, which typically has a negative impact on corporate earnings and economic output. Too much inflation (hyper inflation) can cripple an economy. The U.S. experienced 14% inflation in the 80's, although I'm not suggesting the U.S. faces nearly the same threat today, I am merely pointing out that rising inflation poses a bigger threat to stocks than rising rates, although admittedly often these things do go hand in hand.

There have been inflation worries in the past that never came to fruition. This could be another one of those cases or it could just be the next thing to deal with. Central banks will once again be playing a crucial role.