Quite the week it has been. For much of the year, we have been recommending that periods of market placidity should be used as precious opportunities to assess and re- position. Those benign times are when changes are best made, but of course, human nature being what it is, those times are also when it feels less urgent to make such changes.
Now we have been greeted with volatility, and then some. One to two percent moves daily in stocks; currencies globally declining with the dollar strengthening; and sovereign yields dropping with negative cascade effects on emerging-market and high-yield instruments. Some of these sharp moves may have been triggered by warnings from the IMF that Europe was on the edge of another dip into recession and that global growth is weakening. Some may be a product of continued digestion of the end of quantitative easing by the Fed. And some may be a nervous environment in the face of multiple global concerns such as Ebola spreading and ISIS advancing.
Next week, market attention will turn to the slew of third quarter earnings, which will likely offer some decent upside surprises akin to what we saw in July. Even so, once markets plunge into volatility, it takes a while to subside. We have had a few bouts this year already, early in the year and again in August, and the past week felt even more substantial. While the S&P 500 has only declined about 5% from highs, other areas of the market are much, much weaker, especially small-cap stocks (as measured by the Russell 2000 Index) which are already in correction and are off in excess of 10% from their highs. While this is not an optimal time to trade and react (unless you are a trader…), it may be a time to dip into sectors or asset classes that seemed too pricey only a few months back. The operative word is dip, given that what now looks less expensive may of course be less expensive still if the current downtrend continues.
Still, this sell-off and global market unease has not been triggered by any clear or radical deterioration, or by a sudden unexpected shift in anything other than sentiment. That matters, as absent genuine crisis, markets will sooner or later follow underlying fundamentals, especially stocks. Those fundamentals may not be stellar (and have not been at any point in the past few years), but they are hardly terrible. Markets can detach from that for a while, but not completely.
