The Big Picture
“Fear tends to manifest itself much more quickly than greed. So volatile markets tend to be on the downside. In up markets, volatility tends to gradually decline.” – Philip Roth
A client once asked me how I stay non-emotional during days like we just witnessed. I tell them I am human, I can understand how the emotion comes in. However, this isn’t my first rodeo, and I have a job to do. What benefit would I be to you if I got emotional? It is better to leave emotion at the door. I prefer a plan, and a process.
Worrying is like sitting in a rocking chair, it gives you something to do but doesn’t get you anywhere! – English Proverb
Stick to process.
We witnessed volatility slowly decline to all-time low levels over the last few years. Only to come rushing back in just a couple of days. Merely a couple weeks ago I discussed the “Parabolic” move in the markets. Given the strength of the move and the time since the last pullback in the markets, it should not have been such a surprise when one arrived.
Have a Plan and a Process!
From the Trenches
“Never think that lack of variability is stability. Don’t confuse lack of volatility as stability, ever!” -Naseem Taleb
I believe I’ve used the above quote before, not a bad time to recycle it.
The calm before the storm.
After such a long period of calm, what happened? Keep in mind this pullback is still early and possibly not over so my conclusions are premature and subjective. We will need more time to digest. This is my opinion:
1. The “Parabolic” move! See my email from a couple weeks back. Markets do tend to mean revert.
2. Interest rates on the rise. Rising interest rates have many implications. On one hand they are a sign that the economy is improving. On the other hand they are a sign that we may be later in the business cycle. There are ramifications to rising rates.
3. Extremely subdued volatility.* Many market participants have been betting on and expecting volatility to remain subdued. Very quickly they learned how rapidly volatility can return!
One last important point: It may become more of a norm that corrections happen much faster than in prior business cycles. Culprit? Computer trading algorithms are a good start. We know that a good portion of the market is becoming more automated. During the decline on February 5th; once certain widely followed price levels were breached, the selling amplified to the downside. Automated trading appeared to take over and accelerate the selling. We have witnessed this before, we seem to be witnessing more frequently.
Bottom line: Has the storm begun? I do not believe it has. We are not seeing other indications that a more material event has commenced.
“Short-term volatility is greatest at turning points and diminishes as the trend becomes established.” -George Soros
So have we arrived at a turning point?
Fundamental and economic data remain overall positive and results for fourth quarter 2017 earnings are overall positive.
One trend that appears to be turning may be in the move, and expected continued move, in interest rates. After over 30 years of declining interest rates followed by an extended period of low rates; we may be seeing the turning point. We will be analyzing this closer over the coming weeks and months. This is a topic on its own.
One last important point. For some perspective and mathematical fun: Is a 1000 point move in the Dow Jones Industrial Average (DJIA) something we haven’t seen before? From a nominal standpoint; yes. From a real standpoint, we’ve been here before. Stay with me! Real values adjust nominal values for price level changes over time. Do you remember the week of August 8th, 2011? Of course you don’t, that is why I am here. That week experienced real movements greater than this week.
So far this week: DJIA: Down 4.6% on Monday, Up 2.3% on Tuesday, roughly flat on Wednesday, down 4.2% on Thursday.
Week of Aug. 8th, 2011: Down 5.8% on Monday, Up 3.7% on Tuesday, down 4.9% on Wednesday, up 3.8% on Thursday.
This week began with an over 1100 point drop on Monday for a 4.6% decline in the DJIA. Monday, August 8th, 2011 began the week with an over 600 point drop for a 5.8% decline in the DJIA. August 8th, 2011, witnessed a greater drop in value.
The point is while the manic media will make this seem like some record-breaking event; when put into perspective, we have had more severe drops in the past. Furthermore, with a DJIA trading at 25,000; five-hundred point moves, or 2%, will likely be more commonplace. One-thousand point moves, while not welcome on the downside, may happen from time to time.
Bottom Line: Setbacks are unavoidable in investing. The real question is how to address them as they occur. As well as keeping perspective. Now is the time to discuss questions and concerns.