This past Thursday, the stock market, as measured by the S&P 500 Index, closed less than 2% below the all-time high reached on 1/26/18. The S&P 500 was up 7.5% through the first eighteen trading days of 2018. That was an unprecedented start to a new year, especially considering the market advanced 21.8% in 2017, over double what an investor could anticipate based on long-term historical rates of return.
Prior to the start of trading on Friday, the US Bureau of Labor Statistics released the January employment report. The monthly reading on the health of the US job market showed job growth was stronger than expected. The average hourly earnings showed a significant increase of 2.9% over the prior twelve months. Average hourly earnings are a key metric used to gauge the potential for inflation, as higher compensation rates become embedded in the cost of all goods and services. This increase marked the quickest pace registered since 2009.
The inflation concerns seemed to spark a shift in investor sentiment. The positives of greater labor participation rates and higher wages could now become the catalyst for more significant interest rate increases in 2018. The fear of a tightening Federal Reserve policy became a reason, or at least an excuse, for investors to sell stocks and book profits. Many forecasts now are anticipating a quarter point increase in the fed funds rate at each quarterly Fed meeting in 2018, which would push the overnight lending rate up to 2.5%.
Typically, when interest rates spike up, equities sell off in the near-term. We believe once the stock market has had time to digest the change in interest rate expectations, the bull market in equities should regain its footing. Stronger corporate earnings continue to be reported. So far, over 40% of the companies in the S&P 500 have reported earnings for Q4 with approximately 80% exceeding analyst expectations. A large majority of these companies are raising their 2018 earnings forecasts.
Statistically speaking, the stock market declines 10% about once a year. But we have not experienced a 10% correction since early 2016. Additionally, over the past two years we have not even experienced a 5% pull-back until the last few days. The recent market declines, albeit volatile, are a regular occurrence that should not cause an unnecessary investor reaction. This afternoon’s strong market recovery in the major averages serves as a good reminder that staying the course is the prudent strategy.
Please keep in mind that stock market declines can often occur with greater velocity and speed than market advances. A rapid market decline can create anxiety as it gathers steam and becomes front page news. The stock market in the long run will reflect the trajectory of the overall economy. We believe the recent positive economic trends remain intact. We continue to expect the stock market will reward patient investors over the intermediate and long term.
Marietta Wealth Management, LLC