For the first time in two years, U.S. stocks tumbled into correction territory Thursday, joining broad market indices in Japan and Germany with declines of approximately 10% off recent highs.
Meanwhile, market fundamentals remain strong, compounding the frustration for stock investors monitoring a sell-off that on the surface doesn’t seem to make sense.
After all, global economic data remain upbeat. In addition to last week’s robust U.S. wage growth report, data released Thursday showed U.S. jobless claims fell to a 45-year low. Corporate earnings remain on the upswing, too. Of the S&P 500® companies that had reported fourth-quarter 2017 earnings as of Thursday morning, 78% recorded better-than-expected results. Furthermore, corporate revenue forecasts have increased 2% for 2018.
So, where’s the sense in the stock market sell-off?
An Expected Correction
The stock market is experiencing a long-overdue correction. As we discussed last week, annual stock returns in 2017 and monthly gains in January 2018 were among the best on record. And these stellar results followed several years of solid gains amid historically low volatility. As of late January, the S&P 500 had gone through its longest run without a drawdown of at least 5%. A pullback was becoming increasingly likely.
What’s more, U.S. Treasury yields have taken a dramatic swing upward. Stock investors view rising Treasury yields as a threat, because higher fixed-income interest payments may become more appealing than stock dividends.
Inflation Worries Mounting But May Be Overdone
A combination of inflation concerns, the federal budget deficit, and a growing supply of U.S. Treasuries are driving Treasury yields higher. If inflation picks up too quickly, it could squeeze profits and raise the cost of capital. In addition, investors fear rising inflation will cause the Federal Reserve to hike interest rates more aggressively than expected, which potentially could lead to a slowdown in the U.S. economy and spill over into the broader global economy.
We think 10-year Treasury bond yields are approaching their highs for the year. We believe they could climb as high as 3%, but they likely will move lower by year-end. Inflation has inched up recently, but we do not believe inflationary pressures are strong enough to drive interest rates significantly higher, at least in the near term.
Stay the Course
In our view, the U.S. economy is on solid ground. Employment data is positive, corporate fundamentals remain strong, and companies exhibiting earnings growth should continue to be rewarded. The economic recovery in Europe and Japan is continuing, supported by ongoing accommodative monetary policy, while emerging markets domestic fundamentals remain attractive, in our view, amid strong growth supported by expanding profit margins and attractive relative valuations.
As always, we encourage investors to stick to their long-term investment programs rather than react to short-term market volatility.
Generally, as interest rates rise, bond values will decline. The opposite is true when interest rates decline.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
The opinions expressed are those of Dave MacEwen and Victor Zhang and are no guarantee of the future performance of any American Century Investments fund.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.