Volatility is Back

After 18 months of extraordinary calm, volatility returned these past several days, as trading volumes surged and equity markets plunged. The primary culprit was higher than expected wage growth in the January jobs report, which may have increased fears that the Federal Reserve (Fed) would be more aggressive with interest rate hikes in 2018. However, the selling pressure unmasked a variety of issues, including investor complacency and the difficulty of unwinding crowded and complex trades involving leverage, or borrowed money.

Though never any fun to endure, pullbacks are a normal course for long-term investing. It is important to note that that this market weakness is occurring against the backdrop of solid growth in the U.S. economy and corporate profits. Fiscal policy changes may help support growth in personal consumption and business investment. Moreover, this growth is not simply a domestic phenomenon, as global economies are exhibiting similar patterns boosting both demand and earnings.

We view the recent weakness as an opportunity for suitable investors to put excess cash to work, or, to rebalance diversified portfolios back toward longer-term target allocations. We believe inflation will grow moderately and that the Fed will gradually raise rates three times in 2018 and maintain its balance sheet reduction plan. The yield on the 10-year Treasury currently hovers near the low end of our projected trading range (2.75%–3.25%) and the curve has actually steepened this past week, pointing toward future growth.

Fourth quarter earnings season has been very strong and corporate guidance for 2018 profitability is positive, causing consensus earnings projections to accelerate. Even before the recent equity weakness, forward-looking market price-to-earnings ratios declined to levels more appetizing to long-term investors, in our opinion. Considering this, we will continue to position portfolios toward beneficiaries of the current monetary and fiscal policy dynamics, including value, small caps, financials, industrials, and technology. We maintain our year-end fair value estimate of 2,850–2,900 for the S&P 500 Index. For more on our 2018 forecasts, please see the LPL Research Outlook 2018: Return of the Business Cycle.

 

IMPORTANT DISCLOSURES

Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. The economic forecasts set forth in the presentation may not develop as predicted.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.

Yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. The most frequently reported yield curve compares the 3-month, 2-year, 5-year, and 30-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.

The PE ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher PE ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower PE ratio.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

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