Our experts reveal what’s behind recent market volatility.
Global macro matters
Lara de la Iglesia: Last year was a solid one for global stocks, so the market volatility that has characterized this year might have caught some of us by surprise. Now that we’ve seen a pullback, what should investors be doing? Well, to answer that question, I’m joined today by Senior Investment Strategist Harsh Ahluwalia and Chief Economist Roger Aliaga-Díaz. Guys, thanks for being with me.
Roger Aliaga-Díaz: Thanks, Lara.
Harshdeep Ahluwalia: Thank you.
Lara de la Iglesia: Roger, I want to start with you. Tell us, what’s been behind some of the dramatic pullbacks that we’ve seen in the stock market this year.
Roger Aliaga-Díaz: Yes, heading into 2018, the stock market enjoyed a very good ride, obviously. The S&P 500 has tripled since the loss of the global financial crisis; and, we were, basically, and we are, actually, in the second-longest bull market since the 1920s, pretty much.
But in every bull market, there are corrections, there are periods of high volatility, perhaps triggered by a geopolitical event—Brexit, even the dramatic events of September 11, back in 2001.
Lara de la Iglesia: So let me ask a question though. Was there a specific event that happened here, or are we in a situation where there’s multiple factors coming in that’s causing this volatility?
Roger Aliaga-Díaz: Actually, the latter. I mean there were a series of events in this case, starting with the quick realization from the market and from investors that the low unemployment rate that we’ve been experiencing is finally leading to a little bit of higher wages and wage pressures.
Lara de la Iglesia: In the United States?
Roger Aliaga-Díaz: In the United States mainly and perhaps a little bit behind in some other areas of the world, Europe. But some fears of inflationary pressures, in the case with U.S., the Fed becoming firmer in its plans for rising rates this year.
And the other factor, perhaps more importantly, is that all this is happening with a market that is already a little bit overvalued, with valuations relatively overstretched—something we’ve been warning about since last year, right?
Lara de la Iglesia: Yeah, multiple factors there. So, Harsh, this wasn’t a surprise to us, right, as Roger said. We’ve talked about the possibility of a market correction in our Economic Outlook this year. Your team does a lot of research on that. What are your thoughts around this?
Harshdeep Ahluwalia: Yeah, investors should remember that such market drops are maybe painful, but they’re not that uncommon in the markets. So, for example, the recent thousand-point drop in the Dow Jones Industrial Average was a 4% drop. And there have been 140 such moves throughout history.
Lara de la Iglesia: 140?
Harshdeep Ahluwalia: Yes, absolutely.
Lara de la Iglesia: That’s a lot, okay.
Harshdeep Ahluwalia: Another interesting point is that over the last 20 years, there have been ten corrections in the market; and we define a correction as a 10% decline from the market peaks.
Lara de la Iglesia: Okay.
Harshdeep Ahluwalia: Towards the end of last year, our research showed us that the probability of correction in the U.S. market was about roughly 70%, so we are not really surprised by the drop or by the increase in volatility.
Lara de la Iglesia: So let me make sure I have that stat correct, because I did read that research paper, a 70% chance of correction in the U.S. market over—what was that—
Harshdeep Ahluwalia: Next five years.
Lara de la Iglesia: -the next five years, okay. So volatility in an environment that investors should be aware of but perhaps we might need to get comfortable with. Is that fair?
Harshdeep Ahluwalia: Absolutely.
Roger Aliaga-Díaz: Sure. And an interesting factor there is that over the last 20 years, actually the worst trading days, the days in which the market experienced the sharpest losses, are the days that belong to a year in which the market overall did really well.
Lara de la Iglesia: Okay.
Roger Aliaga-Díaz: So it’s interesting because it puts it in perspective for investors not to overreact to a particular spur in volatility, a market event like the one we saw earlier in February, and keep it in context.
Lara de la Iglesia: Yeah, well what might feel intense and scary in the moment could be, I don’t want to say fleeting, but changing pretty quickly thereafter. Interesting. Thank you guys very much.
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