Canary in the Coal Mine?

It’s an understatement to say that the Great Financial Crisis of 2008/2009 has not easily been forgotten by US equity investors. It looms large in peoples’ psyche even today—eleven years later and well into the second longest economic expansion in US history. Investors and market pundits are extremely busy predicting the arrival of the next US recession.

Volatility is good! Volatility is bad! And other lessons that 2018 has taught us.

An apt description for 2018 might be “Be careful what you wish for.” It was a year that began with great promise and optimism but ended with disappointment along with a healthy dose of anxiety. In January, the change in the tax law was expected to generate higher economic growth than had been experienced over the prior several years. In fact, GDP growth did accelerate, wages, especially for lower income households, began to rise meaningfully, unemployment is now at a 50-year low, the Federal Reserve continued its normalization of monetary policy, and the outlook for corporate profits is strong. So, why is the stock market behaving so badly?

Context for the Correction

Since reaching a peak on September 24th, the stock market (S&P 500) has lost 9.6% of its value as of Friday, November 23rd, taking us back to where we started the year.  Losses have been greatest in the technology sector among previous high fliers, but the selloff has been broad based.  Even though it’s impossible to explain any market movements given the infinite number of factors that influence security prices, following is a list of potential explanations: 

Everything is Connected

The stock market continued to grind higher as an expanding economy and strong earnings growth outweighed concerns about trade wars and fragile politics both here and abroad. During the second quarter, the Gross Domestic Product in the US grew at a rate of 4% while corporate earnings surged by 25%. This economic expansion is predicted to continue for the remainder of the year.

Up in Smoke

There are sectors of speculation in every market that defy reasonable valuations. In the late 1990s, many Internet stocks with flimsy business models were bid up to stratospheric levels. One dozen years ago, speculation in the housing market reached historic proportions as the banks provided easy credit to risky borrowers. Housing prices in many markets are still way below the highs reached during the bubble. Last year, Bitcoin and other crypto currencies exploded higher only to deflate by 50% this year to date.

The latest craze is the cannabis market.