August's higher market volatility continued Wednesday (Aug. 14) as stocks dropped in tandem with long-term interest rates. In six of the last eight trading days, the Dow has moved 1% or more and the TSX index recorded its biggest, yet modest by historical standards, decline this year. But remember that market volatility is a door that swings both ways – on those six days, the Dow rose more than 300 points three times and fell more than 300 points on the other three days
Don't let this bout of volatility shift your attention from the positive fundamentals. The economy and corporate earnings are growing, supported by solid job growth, low interest rates and easier monetary policy globally
After rising sharply in response to the Aug. 13 announcement that some tariffs on Chinese imports would be delayed until December, U.S. stocks reversed and dropped 3% on Aug. 14 due to worries that falling long-term rates may be signaling a recession ahead:
Falling long-term rates and an inverted yield curve are cautious signals that should not be dismissed. In the past, the inverted yield curve (using the three-month bill rate) has been a reliable signal of a recession. However, it's not very timely, since it has led a U.S. market peak by an average of nine months and a recession by 16 months, ranging from six months to more than three years
Lower interest rates globally, helped by expectations of additional central bank rate cuts, are also an input to the economic engine. To the extent low rates offer support to the economy, this is broadly supportive for the stock market over time. As a result, we think the fears have run well ahead of the fundamentals, which is why we recommend staying invested in an appropriate mix of stocks and bonds based on your comfort with risk and goals. Remember that fixed-income investments play an important role in your portfolio because they can help reduce the swings in the value of your investments during times of higher market volatility like the last few days.
We're not surprised market volatility has picked up as overall economic and earnings growth has slowed and interest rates have declined. But a focus on daily fluctuations or worrisome headlines obscures the broader investment landscape, which remains reasonably favorable:
In our view, this is a recipe for the bull market to be extended, but with more bouts of indigestion along the way, just as we've seen several times over the past few years.
Craig Fehr, CFA
Kate Warne, CFA, Ph.D.