Recent Market Volatility
In the last ten trading sessions, the S&P 500 dropped 10% from its all-time high set January 26th and volatility, largely absent the past two years, returned with a vengeance. While we knew a correction was long overdue—the last one was in January of 2016—the violent nature of this turn was stunning. Many investors had been lulled into complacency after 13 consecutive months of positive returns, the longest streak in history.
Although many theories abound, we think the selloff resulted from the market properly reassessing the risk of inflation, given the strong employment and wage growth reports last week, and the implications of higher inflation for interest rates and Fed policy going forward.
In a shocking come from behind victory, Donald Trump won the U.S. Presidential election last night. It was shocking because, as we saw with the Brexit vote in June, most election polls failed to capture the degree of U.S. citizens’ unease and anti-establishment sentiment. As the outcome became clearer money fled global equity markets–at one point the S&P 500 was down over 5%–and moved into safer assets–10 year Treasury bond yields declined a similar percentage. As this is written mid-day Wednesday, the trade has reversed and the S&P 500 is up about 1% and 10 year Treasury yields are higher at almost 2% for the first time since early 2016. So, will President-elect Trump be Good Trump or Bad Trump for markets?
Last week, in what came as a surprise to many, United Kingdom voters elected to leave the European Union. Global market reaction has been swift with the British pound sterling dropping and the dollar and yen strengthening, global equities falling and global bond yields moving lower. Although Friday’s negative market reaction has been significant, we think it will be short-lived.
We believe the greatest negative economic impact will be concentrated in the U.K. with a drop in business and consumer confidence and a decline in business spending. Europe’s growth could weaken by ½-1% this year but we still expect modest GDP growth, not a recession. It seems we are seeing a long-term weakening of the pound sterling and a short‐term weakening of the euro. Equity markets should re‐price quickly and then begin to stabilize, and bond yields will remain lower for longer.