Tom Wald, CIO, Transamerica Asset Management Inc.
The vacation from volatility equity investors seemed to be so enjoying came to an abrupt end during the first week of February when stocks sold off aggressively as evidenced by an 8.5% decline in the Dow Jones Industrial Average (the Dow) between January 26 and February 5. During this same period the S&P 500® dropped 7.8% and NASDAQ 7.2%. When taking into account the morning lows of February 6, the Dow had declined more than 10% from its high, officially touching base in correction territory.
Creating the immediate concerns behind the broad-based selling was a rise in market interest rates and fears of higher inflation, neither of which we believe was sufficient enough to warrant this adverse market reaction.
In regard to interest rates, the 10-year Treasury yield reached 2.85% on February 2, representing a 0.45% increase from its year-end 2017 close. This, in our opinion, should not have been a great surprise to investors. As we wrote in the Transamerica 2018 Market Outlook, we felt there was a strong probability short and long term rates would increase in 2018 based on a strengthening economy, the potential for a steepening yield curve, and the Federal Reserve’s recently announced balance sheet reduction program.
Inflation fears suddenly came into focus on February 2, as in the January Non-Farm Payrolls Employment report Average Hourly Earnings increased to 2.9% annually, its highest rate since 2009. Again, this should not have been any great surprise, as we believe the market has been anticipating a pickup in wage growth for at least a couple of years. Furthermore, we view this increase in wage growth as a highly favorable development.
Amid this not-so-pleasant backdrop of the market, we would like to make the following points:
- First and foremost, nothing, in our opinion, about this selloff has been fundamentally driven, as we believe the economy continues to improve and corporate earnings still look to be on a higher growth trajectory for 2018.
- In the Transamerica 2018 Market Outlook we identified a short term profit taking correction of 10% or more as the most identifiable risk to the market in 2018 and also reported, “If this were to occur, absent a material change to the macroeconomic environment or stock earnings prospects, we would view such a correction as a buying opportunity.”
- In our opinion, this recent selloff likely has more to do with history and human nature than it does interest rates and inflation. The simple math is that between November 8, 2016, and January 26, 2018, the Dow and Nasdaq have risen more than 40%, and the S&P 500 more than 30%.
- Over the past 50 years the S&P 500 has averaged a correction of 8% or more once every 20 months, and it has been 24 months since the last market correction concluded in February of 2016. Given the appreciation in the markets since November of 2016, profit taking was bound to occur at some point, and the aforementioned concerns of higher interest rates and inflation may simply have been a convenient rationale for that.
- Since November of 2016 — the point at which we believe a new bull market began — gains are still strong. As of the close on February 6, the Dow was up more than 34% on a price basis, the S&P 500 up 26%, and NASDAQ up 36%. Therefore, we see the longer term market trends very much in place and well supported by macroeconomic and individual company fundamentals.
These fundamentals include:
- Upcoming first-quarter U.S. gross domestic product (GDP), which we believe could challenge or exceed 3% growth and potentially begin the strongest year of economic growth in more than a decade.
- Previously mentioned rising wage growth, which we view as being overdue and favorable for the economy.
- Rising 2018 corporate earnings estimates, which are now trending above 15% growth.
- Impacts of newly implemented Tax Reform, which will include lower individual and corporate tax rates as well as the pending repatriation of about $ 2.6 trillion of overseas cash back into the U.S. economy.
In summary, market corrections are part of long term investing, and in our opinion the key is less about precisely forecasting them or dodging them, but, under the right circumstances, to potentially take advantage of them.
About the author
Tom Wald is responsible for overseeing the investment and mutual fund product development functions and sub-adviser selection process. He also actively publicizes Transamerica’s investment thought leadership and products to advisors, clients, and the media. Tom has more than 25 years of investment experience and has managed large mutual funds and sub-advised separate account portfolios. Tom holds a bachelor’s degree in political science from Tulane University and an MBA in finance from the Wharton School at the University of Pennsylvania. He has earned the right to use the Chartered Financial Analyst (CFA®) designation.
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