Financial Markets: The Long View
Dear Fellow Investors and Friends,
The Dow Jones Industrial Average and the S&P 500 went into a two-week slide after reaching all-time highs on January 26, 2018. Both stock indexes dropped by more than 10%, a margin that is typically considered a market correction. Analysts have been saying for quite some time that the market was due for a correction, so the drop was not a surprise when we consider the big picture. Even after the correction, the Dow was up 19% over the previous 12 months, and the S&P was up 12.5%.
It is unsettling to experience this kind of volatility, especially after unusually low volatility in 2017 and during the beginning of 2018.
Factors such as strong job creation, low unemployment, and rising wages are great news for U.S workers. However, these circumstances also generated fears on Wall Street of higher inflation, which might drive the Federal Reserve to raise interest rates more quickly than anticipated. At its December 2017 meeting, the Federal Open Market Committee signaled its intention to raise the benchmark federal funds rate three times in 2018, but they could execute further increases if inflation heats up.
Higher rates affect the stock market because investors are more likely to move money out of risky stocks into more stable bonds as fixed-income yields become more attractive. In addition to the jobs reports, two other factors have affected bonds. One is the increased treasury sales to pay for the $1.5 trillion in tax cuts from the recent Tax Cuts and Jobs Act. Another is the bipartisan budget deal that further increased deficit spending. The question is, who will buy these bonds and what are they willing to pay for them?
Mounting government debt is a serious concern. But it is the economy that drives the stock and bond markets in the long term, and the economy is experiencing many positive tail winds.
Only God knows the future. We might see volatility for some time. The wisest course is to maintain perspective, remain patient, focus on long-term goals, and avoid making portfolio decisions based on emotion. And of course, we need to put our hope in our God and not in riches.
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