The first three weeks of the New Year have offered plenty for market participants to digest, with many concerns outlined in our Clear Harbor 2016 Outlook abruptly coming home to roost. U.S. and global economic data continues to underwhelm across multiple metrics, particularly manufacturing activity, inflation expectations, credit health, earnings, and investor and consumer confidence. The International Monetary Fund and the World Bank have reduced their global growth estimates accordingly.
The market response has stung. Equities across many global benchmarks are now in bear-market territory; crude oil prices have already corrected by at least 20% beyond the significant drops in 2014 and 2015. Credit markets are shuddering at home and abroad, and emerging market equities and currencies are experiencing a significant downdraft as well. Despite significant weakness in high-yield credit, investment-grade bonds have benefited, quickly sending the major U.S. benchmark positive on the year. Gold may also have newfound footing as the U.S. dollar struggles to gain new ground.
Against this backdrop, Federal Reserve Chairwoman Janet Yellen may be poised to backtrack on the economic optimism she expressed just last month, when she indicated that markets should anticipate four increases in the Fed funds rate during 2016. That now appears quite aggressive. On the contrary: since her announcement, a meaningful trend has emerged toward lower Treasury yields across a broad maturity spectrum. Although it is perhaps premature to speculate on the course of monetary policy for the whole of 2016—it is, after all, still January—the data, the bond market, and now the equity markets are signaling policy makers and investors to beware economic stagnation, both at home and abroad.
With all of that said, we stress that current market volatility hardly appears abnormal when viewed the lens of history. The S&P 500 has “corrected”—meaning a reduction of at least 10% in a major index—some 15 times over the last 40 years, or about once every 18 months. Prior to the correction that occurred in August 2015, we had not experienced one in nearly four years.
This can be viewed as a predictable step on our long-awaited journey back toward more normalized interest rates. Since the financial crisis, the Fed has pursued extraordinary monetary easing policies in large part for the express purpose of mitigating market volatility. It largely worked: since 2009, investors have been justifiably convinced that the Fed would maintain market order by expanding their asset-purchase program when needed to support prices whenever economic uncertainties threatened.
The basic philosophy is not new. Many still refer to it as “the Greenspan put,” in honor of former Fed Chairman Alan Greenspan’s propensity to lower rates in order to stimulate risk-taking whenever equity markets declined more than 20% in the late ‘80s and ‘90s. However, the two most recent leaders of the Fed have faced greater challenges, and thus embraced this approach to a far greater degree. Last month, when the Fed raised rates for the first time in nine years, investors sensed that this extraordinary protection had disappeared. This returns the many innate uncertainties of investing to the fore—and with them, the increased likelihood of more historically familiar levels of portfolio volatility.
Historical perspective is not a license for complacency. In fact, we believe that current price action across multiple asset classes warrants focus as global monetary policy makers as well as individual public and private corporations attempt to navigate what appears to be a period of structural stagnation for the global economy. We foresee continued volatility as market participants grasp for bearings.
Some abrupt moves—including today’s—will doubtless be up, not down. It is quite common for equity markets to rally temporarily following a period of successive negative technical and fundamental trends. We therefore would not be surprised to see global equity indices find some level of support, if perhaps temporary, near current levels. Further, we recognize that not all of the major economic barometers are trending negative. But on the heels of such sustained optimism, we also note that even a shift from “great” data points to “good” ones can prompt a rather significant shift in expectations for asset prices.
We also would not be surprised to see global monetary authorities look more deeply into their financial toolbox for ways to comfort investors without backsliding entirely to the massive easing programs of 2008-2015 in the United States. Earlier this week, European Central Bank President Mario Draghi pledged continued supportive actions and just this morning Bank of Japan Governor Haruhiko Kuroda stated that the central bank is willing and able to expand their current asset purchase program further if conditions warrant. We would anticipate Washington to take a more accommodative posture as well in response tighter economic conditions. In some important sense, the Greenspan—or “Bernanke” or “Yellen—put remains in place on a global basis. The question is its residual efficacy.
We recognize that for many of our clients, volatile markets can prove less than settling. However, a proper holistic financial strategy—one that incorporates revised personal and financial considerations—can drive a successful asset allocation and portfolio strategy for the long haul, including through inevitable swings in market sentiment. While the latter are beyond the realm of human control, the commitment to defining, safeguarding and advancing your financial objectives thankfully is not.
While it is common to hear chatter about “beating the market,” this is a moment to make sure that market volatility does not beat you—often by undermining your own carefully considered objectives. It remains our privilege to partner with you to help refine those personal objectives and update them regularly. Especially if you have not done so recently, on behalf of the entire Clear Harbor team, I invite you to sit down with us at your convenience, or simply schedule a telephone conversation.