Last year I kept waiting for the stock market to make a correction. As I pointed out several times, the price earnings ratio was out of line with historic values. During 2017, in addition to not having a correction, we saw volatility at extremely low levels. The combination of these two gave many investors the belief that the market couldn’t go down during such good times. This led some of our investors to indicate that they wanted to take more risk in their portfolios. As I told each of them, when the market is rising, you think you can take the downturn, until it occurs.
This correction is long overdue. I believe it didn’t happen earlier only because the change in the tax law, which would give corporations a big tax break, was imminent. The main reason for the correction in the markets, both stock and bond, is the fear that inflation might be rising faster than is good for the economy. Today, February 14, 2018, the government issued a report indicating that inflation for one year, ending in January 2017, had risen 2.1% while core inflation rose 1.9%. Both figures were higher than expected. The FED would like to see an inflation rate of about 2%, indicating a strong and growing economy. As inflation rises, bond yields rise, making it more expensive for businesses to borrow. This can have a negative impact on business profits.
The fundamentals seem to favor a growing economy. Recently reported earning from many companies look good, and the new tax law has not yet come into play for most. Unemployment is very low. Employee wages are up. Consumer spending is up.
As I have said many times, the most important part of investing is diversification by asset class and within asset classes. While you are still affected by a correction, you are less likely to bear the brunt of it. Ascertaining the level of risk, you are really willing to take, is the most important part of determining the proper diversification by asset class for your money.
February 14, 2018