Market Volatility: Most recent comments can be found here.
Bull/Bear Eye Test
We are currently in a bull market. Bull markets by definition make a series of higher highs and higher lows. Thus, if we believe the bull market is still intact, at some point in the future, stocks will make a new all-time high.
If someone told you the economy was headed for a significant recession and the Fed would most likely be lowering interest rates, would you prefer to own growth-oriented stocks or defensive bonds? When investors are concerned about future economic and market outcomes, the desire to own bonds tends to be greater than the desire to own stocks.
YELLOW FLAGS BEFORE STOCKS PEAKED
The chart below shows the performance of stocks (SPY) relative to long-term Treasury bonds (TLT). Early adopters, who saw problems before the financial crisis, started to gravitate toward bonds three months before the S&P 500 peaked in October 2007. Between July and September 2007, the stock/bond ratio shifted from a full-bore bullish look, favoring stocks, to a full-bore bearish look, favoring bonds. This observable shift in asset class behavior said "pay closer attention".
WHAT CAN WE LEARN IN 2018?
The stock/bond ratio in 2018 does not really exhibit any of the concerning characteristics that were present in mid-to-late 2007. The chart still has a full-bore bullish look favoring growth-oriented stocks over defensive-oriented bonds. After consolidating in an indecisive manner for several months (orange box), the ratio broke out in a bullish manner in September 2017. A successful retest of the breakout occurred in November.
This week's video looks at the recent pullback in the context of history. The charts help us answer the most relevant question - does 2018 look like a bull market or the early stages of significant and protracted decline?
"The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd."
WHY ARE BOND YIELDS RISING?
When market participants were concerned about the economy and markets in 2007, they started buying bonds. Today, we have bonds selling off based on increasing confidence in future economic outcomes. An improving economy does not fit the traditional early-stage bear market script. Does it look like a bull market or a bear market?