Recently, the stock market has experienced a lot of volatility. 2017 was one of the least volatile years on record so recent ups and downs may seem concerning after a period of relative calm. But volatility is normal. Take a look at the chart below which shows calendar year returns in blue, and declines during the year in orange. Notice how many years have a positive return (upward pointing blue bar), but an average decline during the year of -14% (downward pointing orange bar).
Many of the serious declines in stocks are associated with recessions as we see in 2000-2002 and 2007-2009 time periods. There still isn't much sign of recession in our current economy, though we will eventually get one since recessions are part of the normal business cycle.
One of the more predictable indicators of a recession is an inverted yield curve. This happens when short-term interest rates are higher than long-term interest rates. Taking a look at the graphic below, notice how the blue line (treasury yield curve) turned negative about 12-18 months before each recession, shown as grey bars, going back to the 1970's. This relationship shows that our yield curve has not yet inverted, it is still positive. Even if it were inverted, history shows that we might have another 12-18 months before the next recession hits. While this indicator may not be perfect at telling the future, it has been reliable in the past and it tells me we are not headed for recession yet. This relationship is something I am watching closely.
So why has the market been more volatile than in the recent past? I think investors are worried about a few things:
1. Rising interest rates - recent comments by Fed officials have been more hawkish, indicating more interest rate increases are coming. As interest rates rise, people are less interested in borrowing money and some industries like housing and auto manufacturing slow down.
2. Midterm elections - a tipping of power in the House of Representatives and possibly the Senate are increasing uncertainty and the market doesn't like uncertainty.
3. Tariffs - the US has been leaning on its trade partners for more favorable trade terms and this is also creating uncertainty and impacting certain industries, especially US exporters. A new trade agreement with China, in particular, seems elusive and China is one of our biggest trading partners. But China exports more to us than we export to them, so trade tensions will likely hurt China more than the US.
4. Corporate profits - US companies have had a great couple of years. Profits have grown in 2017 and 2018 and as corporate earnings grow, stocks typically follow. But given some of the items listed above, a flattening of corporate profits in the future will likely mean less growth for stocks. We don't know if profits will slow, but they might and this uncertainty is weighing on markets. Corporate earnings are currently expected to grow by about 10% in 2019.
So what to do about your portfolio
The views depicted in this material are for information purposes only and are not necessarily those of Cetera Advisor Networks LLC. They should not be considered specific advice or recommendations for any individual. All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. Indices are unmanaged and cannot be invested into directly. Past performance is not indicative of future results.