by Daniel Yu, CFA®, AIF®, REDW Stanley Financial Advisors
As we noted in our recent Year in Review newsletter, we expected volatility to increase in 2018, and here in the early days of February 2018 we see that volatility increasing as the S&P 500 has declined more than 5% in the last two days. Many headlines say that the recent decline is due to increased worries over inflation, and how the Federal Reserve will react to unexpected inflation news. While that may be a part of the rationale for there being more sellers than buyers, we tend to think this is a rather weak argument. Although the two main inflation indicators the Federal Reserve uses have been accelerating in recent months, they are not indicating a rapid return of inflation. It seems other reasons exist for the recent downturn.
At the beginning of the year the forward Price Earnings (P/E) ratio of the S&P 500 was about 18.2x, which was above the 25 year average of 16.0x, but within one standard deviation, and not near the 22x (or more) of the 2000 dot.com bust. Also, fixed income rates have been increasing most of 2018. The US Ten Year Treasury began the year with a rate of 2.45%, but has recently increased to 2.79%, which makes fixed income investments more attractive than they were when the year began. We could be seeing the rotation of assets from equities to fixed income. Finally, the S&P 500 had a positive return for January which makes 15 consecutive months where the S&P 500 had positive monthly returns. This is highly unusual for the S&P 500, and declines were to be expected.
Could the declines we have seen be the beginning of a correction? Yes, it could. Are we expecting a broad economic recession? No, we are not. We anticipate the fiscal stimulus from the recent tax law to take about 12-18 months to fully show up in the market place in terms of changes to household income, and changes to spending at both the household and corporate level. In terms of US GDP growth, we continue to expect for growth to be about 3% in 2018 which is above the 2.1% of recent years. While we evaluate many economic indicators, we are particularly heartened by the ongoing growth in manufacturing, retail sales, job creation, and wages. We are also seeing ongoing growth in international and emerging markets.
The recent market declines reinforce our ongoing commitment to providing diversified and asset allocated portfolios to our clients. Every market cycle has corrections, and having a diversified portfolio helps to reduce some of the volatility from equities during such periods. Despite the recent downturn we continue to have a positive long term outlook for equities. If you have experienced a change in financial circumstances or goals, or if you are concerned about the recent volatility then please contact your relationship manager for a discussion.
Copyright 2018 REDW Stanley Financial Advisors, LLC. All Rights Reserved. This publication is intended for general informational purposes only and should not be construed as investment, financial, tax, or legal advice.
