As of last night’s close, the S&P 500 has dropped 10% in the last nine trading days. Investors are nervous about the rapid escalation in interest rates this year as well as a whiff of inflation with wage gains up 2.9% in January. Many are concerned the Fed will raise rates more than the expected three times this year. However, we do not see panic selling as the main culprit. Rather, we believe computerized trading (now 40% of total market volume) is causing these swift and sharp downturns. Unfortunately, computer algorithm trading is here to stay.
It is important for investors to remember that both economic fundamentals (GDP growth, job gains) and market conditions (strong earnings, lower corporate tax rates) remain favorable. However, our dual concerns remain valuations and excessive optimism. The optimism balloon is quickly being popped, but valuations remain rich at approximately 17x forecast 2018 EPS (still well above long‑term averages).
We don’t know when the near term bottom will be established, but we have all been through plenty of turbulent markets. Volatility and corrections usually create opportunities. They also highlight the importance of disciplined investment management based on individual financial goals. Prudent investors should stay the course.