A Visit from a Long-Lost Acquaintance

Last week, volatility returned to the stock markets after being virtually absent for almost two years. On Friday, U.S. stocks declined by just over 2%, the second large daily decline in less than a week. We will address why such a decline occurred, and what this means for your investment strategy.

As we have repeatedly said, the continual increase in stock values over the past couple of years has mainly occurred because of the growth in 2017 corporate profits and expected continual increases in earnings for the next couple of years. As recently as last month, we warned “the main risk is … if earnings growth over the next couple of years is less than what’s been forecasted, stock prices will likely decline.” On Friday, Google announced weaker than expected earnings. Energy companies Exxon Mobil and Chevron also announced disappointing profits. And overseas, Deutsche Bank announced a loss in earnings. Such wide spread poor results can cause investors to re-evaluate their optimistic earnings forecasts, which will cause stock prices to fall. Indeed, stock prices had risen 7% in the first four weeks because until last week, earnings announcements had been overwhelmingly positive. Moreover, ironically, good news about job growth in the U.S. also caused concerns about inflation.

We want to put this volatility in perspective. Since mid-2016, the markets have had surprisingly little downward movement. For example, during the 30 years between 1986 and 2015, stock market values fell by at least 1% on average once every eight days. That means in a typical month, we will experience two or three such drops, and in a typical year, we will experience about 30 daily declines of at least 1%. In 2017, we saw only three such declines during the entire year. Last week seems unusual only in the context of the past couple of years.

Our strategies are built around long-term investors – people who don’t plan on using most of their investments for the next few years. If you are such an investor, there is no reason to worry about the events of last week. After all, as of this morning, stocks are up by 3% for the year. However, this is a good reminder that volatility will probably return to more normal levels in the near future, and we should all base our expectations accordingly.

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