Volatility strikes back. Is this the start of a bear market?

  • First, the high frequency U.S. data suggests inflation is starting to re-accelerate—wage inflation in the January employment report surprised to the upside and touched its highest level since 2009.2 This pushed the 10-year U.S. Treasury yield up to its highest level in four years.3Higher discount rates are proving to be a challenge to the elevated valuation levels of U.S. stocks.

  • Second, investor sentiment has taken a hit—market psychology was bordering on euphoria in late January and is coming back down to earth now. For example, the share of respondents expecting stock prices to increase in the Conference Board’s Consumer Confidence Survey4 hit an all-time high in January. Our research teams have also pointed to evidence that a lot of the selling activity has been driven by technical reversals in trend-following strategies. A step back toward rationality should be a healthy development for the market outlook.

Economic and earnings fundamentals, by contrast, are actually quite robust at the moment. The J.P.Morgan Global Manufacturing PMI hovered close to an 82-month high in January.5 And the fourth quarter corporate earnings season in the U.S. is tracking ahead of schedule—over 80% of S&P 500® Index companies are beating consensus revenue estimates (i.e., one of the highest beat rates in many years), and earnings growth is tracking north of 13%.6

Bottom line: We will continue to monitor economic and market conditions carefully in the coming days. But for the time being, this looks like a healthy correction in markets, rather than the onset of a bear market. Depending on the depth of the dip that we see in asset prices, this selloff could create an attractive entry point for investors to take more risk.

Recent events highlight the importance of a diversified, multi-asset investment strategy. Even with the latest selloff, valuations on U.S. equities are still expensive. And elevated valuations create a negative asymmetry to the market outlook—the upside potential is limited, but the drawdown potential can be significant.

In anticipation of a low-return, high-volatility environment, my colleagues at Russell Investments have developed a Downside Management Toolkit to help our clients navigate these swings in markets. This online resource includes research from our thought leaders on the market outlook, the importance of downside protection and our unique approach to multi-asset investing. It can be difficult to stay invested during periods of market stress. Buying low and selling high is hard. But it is precisely this emotional aspect to markets that creates opportunity for a disciplined investment process to add value in the long-run.

1 Source: http://www.cmegroup.com/trading/equity-index/us-index/e-mini-sandp500.html
2 Source: Bureau of Labor Statistics
3 Source: Thomson Reuters Datastream
4 Source: Conference Board
5 Source: J.P.Morgan and IHS Markit
6 Source: FactSet