Just as one cold wave follows another this winter, waves of market volatility have become the norm in 2014. Do the waves of volatility forecast a change in the investment climate, or is it just a naturally recurring market rhythm? Based on our readings, seasonal volatility does not appear to be a precursor of a chillier 2014, but rather, part of a healthy process to drive out an excessively rosy market outlook.
Like the cold weather, we believe volatility, too, will pass. The global economic recovery may be tenuous, but not in trouble. The pullback could become a correction, but that’s not a bad thing.
Global economic recovery shaky but not in trouble. Economic recovery worldwide remains wobbly and excessively vulnerable to the economies of the U.S. and China, as well as too dependent on central bank stimulus, but there’s no reason to expect growth to turn into contraction, according to The Economist. “Investors’ gloom is overdone. A handful of disappointing numbers does not mean that America’s underlying recovery is stalling… January’s spate of feeble statistics—from weak manufacturing orders to low car sales—can be explained, in part, by the weather… Investors should recover their nerve as they realize that the bottom is not falling out of the world economy.” The Economist (tiered subscription model)
So Cruel: Pullback Could Become Correction. Liz Ann Sonders of Charles Schwab has been alerting investors of the likelihood of a correction since late last year, largely due to elevated market optimism and the beginning of the Federal Reserve’s tapering of its large scale asset purchase program. As markets test downside thresholds, further declines could set the stage for a legitimate correction (defined as a drop of at least 10%). Pullbacks in the magnitude of 7.5% – 9% usually are associated with turning points in Federal Reserve policy. Pullback duration usually lasts two-to-three months, followed by a recovery and a couple of quarters of range-bound trading before the uptrend resumes. “This seems like a good roadmap to consider for the next few months.”
The case for a healthy correction. “Corrections in share prices can be healthy. Markets rarely move up in a straight line. They are driven by human emotions; they tend to overshoot, in both directions. Bring share prices down by 10 percent, and prices are more realistic, and new investors are more comfortable about entering the market. If the momentum continues without a correction, the danger is of a bubble that can only be corrected by a far sharper and more damaging fall.” As of this writing, a full scale correction has not occurred. Financial Times (tiered subscription model).
And in case you missed it, click here to read last week’s blog post which focuses on the issues related to the current choppy market.
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J. Mark Nickell & Co.
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