Market Insights – Stock MarketFebruary 5, 2018
- The market had a very strong negative reaction to some better than expected news about jobs. The Friday jobs report indicated unemployment was very low and wages appear to be increasing faster than anticipated. The market’s negative reaction may seem counterintuitive considering what, on the surface, appears to be good news about a strengthening economy. After all, low unemployment and higher wages should mean stronger spending and lead to GDP growth. However, the market sees this condition as inflationary resulting in the drop that occurred.
- Bond yields moved higher as the interest paid on ten-year treasuries rose 5 basis points to 2.835% (Bloomberg). This yield is doubly painful resulting in decreased bond values as well as putting more pressure on portfolios.
- When you investigate further, you can begin to understand greater than expected inflation means the Federal Reserve may increase interest rates resulting in less low-cost money in the system. For this reason, equities reacted the way they did despite very positive earnings reports.
Increased volatility should not be a surprise as the market digests this information. Volatility has been historically low for some time. Our firm’s Portfolio Management Committee (PMC) met Tuesday and decided to make a change in our asset allocation directly impacting client accounts in advance of this pullback. As a firm, we traded accounts to decrease exposure to high-yield bonds and increased exposure to real assets and infrastructure. This re-balance also allowed us to align portfolios and take profits. The increase in real assets was decided because they have historically been a hedge against inflation. This action is in addition to our overseas allocation which also should serve as an inflation hedge.
We believe these economic principles may be the beginning of a longer-term trend that may continue for some time and have positioned portfolios accordingly. We have talked about increases in interest rates for many years now, at it appears this may be where it begins to occur. In our January newsletter we discussed the potential for increased volatility. Volatility is not always a terrible thing. Dips in prices allow us to deploy cash and buy into investments at a lower value.
Economic activity remains strong globally, the yield curve is starting to steepen, earnings remain strong, wages are increasing, the dollar has been weakening which narrow the gap in trade, and the tax cuts are just beginning to permeate through the economy. For those reasons, we do not see the need for a larger change. We will continue to monitor portfolios and adjust. The market has been doing so well lately, this pullback is a reminder investing does involve risk and with potential returns comes the chance for losses like we experienced last week. Building customized transparent portfolios with an emphasis on quality holdings is key to keeping emotions from guiding the decision-making process. If you would like to discuss your portfolio in greater detail, please feel free to let us know.
Reese Veltenaar and Beth Tremaine