Everybody Take a Deep Breath

Anyone that has observed markets for any extended period of time knew the uninterrupted uptrend we enjoyed for the last year and more was not normal and market corrections were bound to happen. Last week, with an attention getting decline of 2 ½ on Friday saw buyers back off and program traders hitting sell buttons with enthusiasm. This new selling comes from a point where most major averages were hitting all-time highs in late January. This type of selling was bound to happen with high stock prices and high valuations. The market setup before Friday’s selloff was unhealthy. The uptrend could not be sustained at the positive clip we were experiencing. Now, we are entering a corrective process that will push stocks lower to more attractive valuations based on improving corporate fundamentals and an improving U.S. and global economy. Time to take a chill pill.

The short term process may continue to be violent until long term investors and corporate buybacks come in to purchase stocks at attractive prices. Volatility was basically absent last year in most markets. Again, it would be normal for volatility to pick up from historic low levels and create bigger swings up and down. The quick negative reaction Friday was likely triggered by the sharp weekly rise in 10 year U.S. government bond yields. The volatility index or VIX rose sharply Friday and early Monday. I would expect the VIX to calm down this week as investors await signals that the 10 year yields (2.85%) has reached a short term peak level. Sure, I am aware that a 10 year bond yield of 3% looks like a magnate for an intermediate target but think the short term move looks a bit extreme to continue at this weekly pace. Long term a 3% 10 year bond yield remains low by historical norms.

As we continue to roll through earnings season, I believe a majority of reports have been quite strong. Many of our favorite companies are increasing full year guidance and increasing cash flow, dividends, and stock buyback programs. Again, don’t let the emotion of the moment deride the positive underlying fundamentals. The only real question is what are you/we willing to pay for those improving earnings and cash flows? This is why interest rates need to calm down. If interest rates continue to rise sharply from here, it will cause investors to reprice stocks lower. If rates calm down, buyers will come back into stocks modestly lower from current levels. So, I plan to stay focused on 10 year interest rates and look for signs of buyers coming back into the market.

Honestly, it is not worth getting all emotional about short term moves in the market. Emotion is a detriment to long term returns. Short term anything can happen. I am actually looking forward to the market this week. I expect the emotion of the moment will create some nice buying opportunities.

Have a great week,

Roger N. Steed

February 5, 2018

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