The tremors that have battered financial markets recently have been nerve-wracking. But remember, the market is not the economy. Economic growth can persist even when markets decline, and that growth can eventually help to stop the slide.
Over the last week, US equities have surrendered their gains for the year and then some, volatility has spiked, and interest rates have jumped amid worries that the US economy may be overheating. This is all unsettling for investors, and it’s not easy to see things in perspective in the heat of the moment.
But it’s worth remembering that the US economy is still performing well and is likely to continue to shine over the next few quarters. Market volatility of this degree certainly doesn’t guarantee that we’re headed for a recession. The 1987 stock market crash was far more severe, but it didn’t lead to a recession. In fact, the market regained and surpassed its precrisis high within two years.
It’s also important to put the recent moves in context. Sure, the stock market is down about 2% so far this year. But it’s still up almost 15% over the last 12 months and roughly 40% over the last two years. That’s a stellar performance by almost any standard.
Volatility: The New (Old) Normal
What’s more, it’s normal for markets to be volatile. The 10% decline in the S&P 500 Index from its recent peak isn’t unique even within this cycle. We experienced similar declines in 2015 and 2016. It was the absence of a significant pullback in 2017 that was unusual by historical standards. Against that background, the recent pullback is not necessarily cause for alarm.
So what does the recent burst of market volatility mean? Well, pretty much what we’ve been saying in our recent economic forecasts: inflation and interest rates are likely to rise in 2018, which should limit the scope of future equity market gains. In other words, investors shouldn’t expect an indefinite continuation of the large and uninterrupted stock increases they enjoyed in 2017.
Now, it’s true that we didn’t expect recent market trends to reverse quite as rapidly as they have. Nor do we think markets will keep this pace up. But the basic direction does makes sense.