Stocks, Bonds and Volatility

February 7, 2018

Volatility has returned with a vengeance to the global financial markets. In the past week, we have seen several gyrations of a thousand points or more in the stock market and a continuation of the recent sell-off in the bond market.  In our opinion, the rise in interest rates and the unanticipated strength in the economy, as witnessed by last week’s report on wage growth and the employment indicators, precipitated the recent sell-off.

The stock market has given-up this year’s six to seven percent gain and is currently up just one half of a percent for the year. The fixed income market has, year to date, fared much worse. The five-year US Treasury has returned -1.3% and the intermediate corporate bond index has returned -2.1%.

We would be surprised if the stock market volatility abates quickly. Interest rates most likely are in the early stages of a sustain drift upward as the global, synchronized economic expansion continues.  Stocks will eventually adjust to higher interest rates and begin to focus more on corporate profits.  The longer-term outlook, 3-5 years, for stocks is benign. Unfortunately, the outlook for bonds remains, at best, uncertain. Should wage growth accelerate in coming months then bonds could enter a protracted bear market.

We are in the process of rebalancing portfolios so that current stock allocations are consistent with clients’ risk-based target allocations. We are conducting a complete overhaul of the fixed-income holdings.  Wherever possible we will be direct buyers of U.S. Treasuries and ladder maturities to hedge rising interest rates.  We will also be buyers of inflation-protected US Treasury bonds (TIPS).  Our holdings of corporate bonds will be tilted to short to intermediate durations until yields move higher.

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