It has been an interesting and chaotic month in the U.S. equity markets. Very calm seas in the prior two years led many investors to believe that volatility was dead, and the stock market would continue its steady march upward forever.
The very long period of low volatility came to an end on Jan. 27, 2018, when fears of inflation reared its head for the first time in a long time. So many investors had bet on continued low volatility, that the resulting 10 percent market correction was exacerbated and fueled somewhat by dislocations in the volatility index (VIX) products, many of which declined more than 90 percent in value. A sleepy, low-volatility dream turned into a nightmare for many short-term speculators.
However, the clearing of the risky volatility market trades happened quickly, and the VIX index has declined from 50 at the high to 16 currently, and the stock market has resumed its climb upward.
We feel that equity gains have resumed after a very volatile month, for four very good reasons:
Although the market goes through spasms of worry about impending increases in inflation, we have not seen many concrete signs of higher price levels yet. And looking at history, the stock market has seen its best years when the inflation level is between 2 percent and 3 percent, where it is now. History shows that stock multiples do not contract much until inflation nears the 4 percent level. “Good” inflation is an increase in wage growth, and “bad” inflation comes in the form of much higher prices for goods and services. So far, we are only seeing good inflation.
Westwood is forever vigilant in looking for excesses in the capital markets, and managing risks for our clients. We feel that the stock market rise has been very rational thus far and is based on many positive economic factors in 2018.
C.J. MacDonald, CFA
Senior Vice President, Westwood Wealth Management