We take a deeper dive into the volatility that sent markets tumbling in early February.
The elastic snapped as it always does when it gets stretched too far. Only hindsight will tell us where the bottom lie. Picking short-term bottoms remains the search for the holy grail. Instead, we review the economic data prior to the correction, which shows a strong foundation. Given the underlying strength, we do not expect this foundation to sustainably deteriorate through 2018.
Volatility Anomaly Sunsets
It’s never different this time. Not when it comes to financial markets. Reversion to the mean is relentless and equity valuations and equity volatility eventually find a middle-ground over time. Timing the call for the inevitable turn toward normalcy, or the onset of a market correction remains the holy grail. Those that call it exactly are lucky. Those that expect it are adept at sidestepping emotion and applying seasoned common sense. It’s simple and difficult simultaneously.
The rally of 2016-2017 and January 2018 is similar to past occasions when valuations were stretched and volatility was abnormally low. Such divergence from the mean can last for only so-long until the elastic eventually snaps. This time it seems the elastic is reverberating harder than most, yet the recent action is likely just some reversion (see a pattern here?) from the smooth ride markets enjoyed in 2017. Said another way: the bigger they are, in terms of market rallies, the harder they seem to fall.
Notice we have not yet cited one piece of data in our attempt to explain the market’s move. None is really needed, although there are indeed numbers to which we will point. Momentum (stocks up, volatility down) finally waned as its always does. In terms of the correction, we were overdue.