EQM Capital LLC – Understanding the Recent Market Correction

Posted on Feb 9, 2018

The stock market has suffered its worst performance week in 9 years since October 2008, as the Dow, S&P 500, and NASDAQ all fell into “correction” territory, defined as a 10% drop from most recent highs. The correction seems particularly brutal following a strong 2017 market which suffered few hiccups along the way.  Up until January 30, the S&P 500 Index had not fallen more than a 1% since last August.

Besides the fact that we were long overdue for a pullback, several other factors have spurred the correction on. Last Friday, a surprising jump in U.S. wage growth intensified concerns about inflation and the need for the Federal Reserve and its new Chairman Jerome Powell to be more aggressive in raising interest rates.  And this week, a congressional budget deal that boosts federal spending sharply on the heels of big tax cuts, has added more fuel to the fire, sending the 10-year Treasury yield to a four-year high of 2.88%, up from 2.41% at year end.

Another piece of the puzzle is the sharp rise in the market’s fear gauge, the CBOE Volatility Index, or the VIX. At the end of January, the VIX was at a calm 14.  It currently is hovering just below 40 after spiking to 50 earlier in the week.  This sharp, unexpected spike in volatility has already forced one short volatility ETF, the XIV, to unwind and shutdown on February 20.  Such events create even more fear and instability.

Across the pond, an increasingly hawkish Bank of England is likely to raise interest rates with other central banks likely to follow suit to cool down their economies. After years of propping up economic growth with low interest rates and lots of liquidity post the global financial crisis, the global economy may finally be capable of standing on its own two feet. Part of this week’s sell-off is investors trying to digest and reprice the fact that things have returned back to “normal” which ironically is the result of good economic news overall.

Clients should remain calm and focused on their long-term investment goals with the assurance that the market is paring down some of the excess of last year and that the fundamental underpinnings of the stock market such as corporate earnings and economic growth still remain very positive for the remainder of the year.


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