The Week in Review
- Overheated Inflation Worries
- Consumers Continue to Drive Growth
- Putting Volatility Into Perspective
- Looking Ahead
What a difference a week makes. After four days of market losses punctuated by one day’s attempt at a rebound and handwringing headlines early in the month, through Thursday night’s close, the Dow Jones Industrial Average and S&P 500 had each posted their best five-day rally in more than six years—up 5.8% and 5.6%, respectively.
The price moves have been astounding in comparison to recent history, yet normal if we take a longer view. Last year, the average move in the Dow Jones Industrial Average, either up or down, was just 68 points. So far this year the average Dow move is almost four times as great. What changed? We’re not sure, but we do know what hasn’t changed.
As we have noted time and again, we are currently in the midst of the second-longest economic expansion on record. We understand why that factor alone has some pundits talking about being in the latter stage of this expansion’s cycle; a stage that typically creates higher inflation. Yes, higher inflation may be in the offing, but for reasons we’ll expand on below, we think fear of inflation is overblown.
For the year through Thursday, the Dow Jones Industrial Average has returned 2.3%, while the broader S&P 500 has gained 2.4%. The MSCI EAFE index, a measure of developed international stock markets, is up 0.5%. As of Thursday, the yield on the Bloomberg Barclays U.S. Aggregate Bond index has climbed to 3.15% from 2.71% at 2017’s end. On a total return basis, the U.S. bond market has lost 2.2% for the year.
Overheated Inflation Worries
Inflation, the rate at which prices rise and money’s purchasing power is gauged, is Wall Street’s latest bugbear. While investors seemed nonplussed to see consumer prices rise 2.1% in the 12 months through January, in fact the number was virtually unchanged from a month ago and lower than November’s reading. Core CPI (which excludes volatile food and energy prices) saw its 12-month rate rise fractionally to 1.8% from 1.7%. It should be said that January inflation numbers are typically a bit overstated due to seasonal factors, hence we did not see anything that troubled us in these reports.
Still, it was clear that inflation worries were influencing investors’ and traders’ behavior. With prices near all-time highs, fear-driven momentum can create exaggerated moves in an instant. But we continue to think that inflation fears are themselves overinflated and conflated with anxiety over higher interest rates. Higher inflation is being confused with the possibility of high interest rates, rather than simply higher interest rates—a big difference.
The inflation that we are experiencing today primarily reflects the strong economic growth of the past several years. As for the Federal Reserve, keeping inflation at bay is an easier task than trying to reverse a recession. We’re not even at the point where the Fed is trying to tame inflation. Instead, our view is that the Fed is trying to manage inflation so it doesn’t reach the boiling point.
Meantime, the economy remains in the Goldilocks realm of low interest rates and low inflation, with no hard evidence that the U.S. or global expansion is about to reverse course into recession.
Consumers Continue to Drive Growth
Well employed and confident consumers are good news for a consumer-driven economy. Retail sales were up 3.6% in January from the same time last year, even as a post-holiday pullback saw sales slump from December’s spending splurge. Slowing January spending is often mistakenly seen as consumers stepping away from their confident purchasing trend. However, if past is prologue, consumer spending doesn’t falter until the job market breaks down. For now, unemployment remains at 17-year lows and consumers are just now starting to see a few more dollars in their paychecks to spend, courtesy of minimum wage hikes and reduced taxes.
One need only look to the homebuilding sector for signs of optimism about Americans’ continuing ability to spend and spend big. The number of new homes under construction rose 9.7% in January, the third increase in the last four months, far surpassing expectations. You’ve heard us say before that while new home sales make up a small portion of the overall housing market, they are a potent economic golden goose as new dwellings are built, financed and furnished, creating jobs and spending every step of the way.
Putting Volatility Into Perspective
The past two weeks have seen a resurgence of the use of the term “volatility.” Merriam-Webster defines volatility as “a tendency to change quickly and unpredictably.” In investment terms, volatility refers to the magnitude of a security’s price moves, with higher volatility typically signaling higher risk. While volatility has certainly increased this year, from an informed and historic perspective, it is not abnormally high. The heightened sensitivity regarding swings in the markets is clearly being influenced by the fact that market prices were “less volatile” for an uncharacteristically long period of time. Take a look at the Chicago Board Options Exchange Volatility Index—referred to as the VIX, or “fear gauge”—below, which had an average level of just under 20 over the last 28-plus years.
The chart shows that markets are currently not more volatile than usual today; though in the context of how placid they’ve been the last few years, 2017 in particular, there has been an increase. We just suggest you keep this in mind when you hear commentators getting their dander up about elevated volatility.
The Braver Capital Management offices will be closed Monday in observance of Presidents Day, but when we return to our desks next week, we’ll be reviewing the minutes from last month’s Federal Reserve meeting, reads on the manufacturing and service sectors, January’s existing home sales and the latest look at leading economic indicators.
We say this time and again because it bears repeating: Volatility loves the kind of vacuum created by weeks when economic news is slow. And last week, this week and next week are three of the lightest reporting weeks of the year.
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Please note: This update was prepared on Friday, February 16, 2018, prior to the market’s close.
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