Should Investors Be Worried about This Stock Market Correction?
Nothing has actually changed
Investors who were used to the calm for over 14 months were suddenly awakened by a jolt of volatility. Events that led to the decline of stock markets in the last two sessions don’t reflect the strength of the US economy nor the performance of the underlying companies. The trigger for the sell-off was the rising rates, but that is not a surprise. The US Fed has been suggesting three rate hikes through its dot-plot projections and it re-emphasized this at the January meeting. The only change in the Fed’s message was its outlook for inflation, which the Fed said could meet its 2% target in 2018.
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Too much running leads to exhaustion
The US and the global markets have had an excellent run in the last 14 to 18 months thanks to the improving global economic performance. Many indexes have continuously set new highs, making investors wonder how long the dream run can continue.
There were talks about a correction at the end of 2017, but January 2018 turned out to be another strong month. A correction, as explained in the first part of this series, would mean a drop of 10% in value and recent entrants into the bull run could be caught in the downward spiral and be the most worried. For instance, ETFs like the SPDR S&P 500 ETF (SPY) and the Dow Jones Industrial Average (DIA), which track the performance of the S&P 500 and the Dow indexes, have lost 6.4% and 7.1% of their value over the last two trading sessions, wiping out all of January’s gains. However, they are still holding on to the gains of 2017.
The underlying fundamentals haven’t changed
To summarize, this sudden jolt of volatility in the stock markets should be considered as a reality check. The underlying fundamentals of the US economy have been improving, and we are also yet to see any profound impact from tax cuts on US industry. The unemployment rate, on the other hand, is falling, which could lead to higher wages and eventually higher inflation (TIP) and higher rates. These macroeconomic developments would depend on a lot of factors and usually take time to improve. The US Fed would likely be careful enough not to take any actions that could disturb financial stability. Going forward, the pace of stock price appreciation could be slower than what investors have been used to in the last 14 months.