New Federal Reserve Chairman Jerome Powell probably did not expect U.S. equity markets to sell off more than 4% on his first day in office, but sell off they did on February 5, wiping out an estimated $4 trillion in global equity market value in the process. And while pundits correctly describe the 1175 point drop in the Dow Jones Industrial Average as the “largest point decline in history”, that still leaves the Dow off a mere 1.5% in 2018, and about 9% off its all-time high reached just last week.

Of course the concern is for what the future holds, and on that topic we have a few thoughts but no crystal ball. Global investors have quickly grown concerned with rising interest rates, especially in the U.S., where the yield on the 10-year Treasury Note has jumped to a high of 2.85% yesterday from 2.3% at the beginning of the year. Despite clear signals from the Federal Reserve that higher short-term rates are in the forecast, Friday’s employment report, which showed continued strong growth in new jobs and wage growth of close to 3%, appears to have quickly focused investors on the prospects for higher inflation.

We have argued that 3%+ growth in wages was necessary to fuel healthy advances in U.S. GDP, which is heavily dependent upon consumer spending. Increasing wages should not be a surprise to anyone who has watched the unemployment rate drop to its current level of 4.1%, well below the level most economists believed would put upward pressure on wages.
We believe inflationary pressures have been building for some time now. The Trump Administration chose a poor time, in our opinion, to loosen fiscal policy (via its tax reform/cut package) while the Fed still had the monetary spigots wide open. The Fed now finds itself having to battle economic growth while trying to restore “dry powder” by withdrawing some of the $4 trillion in liquidity it has injected into the economy over the last nine years. This is no simple task, and the risk to inflation remains to the upside.

At this point it appears to us that corporate earnings are reasonably solid, and 2018 earnings forecasts support share prices at about these levels with the 10-year Treasury yield in the ballpark of 3%. We have warned that most markets were priced assuming volatility levels remained at historic low levels, and that any bumps in the road could cause some loss in confidence. We have now hit one of those bumps, as volatility has spiked (at least in the short run), and we will have to wait to see how much this troubles investors around the world in the days and weeks ahead.

Our approach has not changed. We are looking to invest in solid businesses that are both well-managed and well-capitalized at attractive prices. We are long term investors, and recognize that there may be very high levels of “noise” in the market for many days to come. Our advice is to make sure your asset allocation fits your needs, rebalance to stay within that allocation, and continue to look at long-term expected returns rather than day to day market levels when evaluating your investment portfolio.


This commentary is provided courtesy of our affiliate, Great Lakes Advisors. This manager commentary represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice. No mention of particular securities should be construed as a recommendation or considered an offer to sell or a solicitation to buy any securities.