Some of you may recall the following from my January 18th quarterly letter:
“I believe the greatest risk to the financial markets to be inflation and the actions of the Fed. The Fed expects three more rate increases in 2018; the markets think it will be just two. Should market expectations be too low, which I think is a high probability, this could finally result in some volatility.”
Lo and behold, the stock market is waking up to the possibility that the Fed may need to raise interest rates three more times this year – if not four – to fend off inflation. I went on to note in my letter:
“The tax reform could add fuel to an already healthy economy at full employment, forcing the Fed to get more proactive raising rates to fend off inflation.”
And this concern is what we saw with last Friday’s jobs report. Wages rose 2.9% year over year, which is the largest increase since June 2009. Rising wages are widely viewed as a precursor to inflation. While a growing economy is generally viewed as a good thing for the financial markets, it is possible for growth to be so strong that it warrants a stronger response by the Fed. There is a risk that if the Fed overreacts, it could stifle the economy and with it the financial markets.
Stocks have gone virtually straight up ever since the election in November 2016. They cannot go straight up forever, and have been long overdue for a correction. The yield curve which I have referenced numerous times is solidly positive, which historically means that a recession is not on the horizon. This leads me to believe that this correction in stocks will be shallower and of shorter duration than what we would see with a recession.
While anything can happen, I believe that most of the damage is done at this point as today we nearly achieved a 10% correction in stocks off of their high point hit less than two weeks ago. What usually follows a plunge such as this is an attempt to rally, a re-test of the recent lows (which may very well break to new lows), followed by a period of base building (sideways action).
It is times like this when having clearly defined objectives and a disciplined strategy to achieve them can pay dividends.
Glenn S. Rank, CIMA®
Certified Investment Management Analyst®