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Stock Market Outlook: Back to a More Volatile Normal?

A period of remarkable calm for U.S. stocks ended in February. Volatility has made a comeback, and people on Wall Street expect it to stay awhile.
Investing, Investing Data, Investing Strategy, Investments
The U.S. stock market is in a so-called melt-up.

The good times in the U.S. stock market couldn’t last forever. And in February, those good times — a prolonged period of remarkable calm and a series of record highs — finally came to an end.

In case you missed it, here’s a recap: In a two-week span, the Standard & Poor’s 500 Index tumbled 10%, succumbing to its first correction in about two years. Among the causes were signs of faster inflation, which spooked investors. They feared that the Federal Reserve might raise interest rates more times this year, and in turn raise borrowing costs for companies.

While the market has mostly bounced back somewhat from its sudden drop — it’s down more than 5% from a January high — March could bring more turbulence. That’s because now that market volatility has roared back, many people on Wall Street don’t see it going away anytime soon. (Not spooked by volatility? Learn more about how to invest in stocks.)

Here’s what professional investors will be watching during March.

What’s normal?

Because it’d been so long since stock prices had swung wildly, the market’s sharp moves in February felt abnormal to some investors, even if such volatility is typical by historic standards. So what’s normal now?

You should get used to a world that has sharper, or bigger, moves again.

Frank Cappelleri, executive director at Instinet

For one, volatility, or wild swings in stock prices. So far this year, the S&P 500 has risen or fallen more than 1% on 14 days — or 35% of the time. “That’s getting back to normal, so to speak,” says Frank Cappelleri, executive director at brokerage firm Instinet. Moves of such magnitude happened only eight times in 2017, compared with 48 times in 2016.

Market corrections, like the most recent one, also are normal. The recent market turmoil doesn’t mean the current bull-market cycle is ending. Rather, the market’s rally is likely to continue, even if it’s not as “squeaky clean” as it was last year, Cappelleri says. “You should get used to a world that has sharper, or bigger, moves again.”

That may mean a deviation from what’s been normal in the past. March historically is a middle-of-the-road month in the stock market, with the S&P 500 delivering average monthly returns of 0.6%, according to data compiled by Yardeni Research.

» Unprepared for volatility? Here’s what you should know about market crashes

While long-term investors should strive to be “agnostic” to market turmoil, there will be some interesting dynamics to watch post-correction, Cappelleri says. Specifically, he’ll monitor how quickly individual stocks rebound to their pre-sell-off highs; which industries lead the move higher; and whether financial stocks — which account for about 15% of the S&P 500 — support the market rally, he adds.

What to watch: The stock market still is digesting the recent sell-off and its causes, so don’t be surprised if there are further declines ahead.

Tax reform in the wild

The new tax law went into effect Jan. 1, and now investors are looking for signs it will continue to buoy corporate earnings, and, by extension, drive stock prices higher.

2018 is shaping up as a year when we’ll see tension between economic strength and the policy reaction to that.

Alan Gayle, president at Via Nova Investment Management

“By March, we should start to see some traction from tax reform,” says Alan Gayle, president at Via Nova Investment Management, a registered investment advisor. While working Americans already have seen some benefit in their take-home pay — which could translate to more spending — publicly traded companies still are “digesting the nuances” of tax reform, he adds.

Specifically, Gayle will watch for whether companies raise their estimates for quarterly profit because of tax reform and how they’ll spend money saved from lower tax rates. That may include stock buybacks, which drive prices higher, capital spending projects or bonuses to workers. “All of this is generally going to be positive, but the question then is going to be how the Federal Reserve and bond market are going to respond,” Gayle says.

Heightened anxiety about the Fed’s possible interest rate increases this year has driven market volatility, along with the recent rise in Treasury yields. The central bank is slated to meet March 20-21, and investors currently expect, with about 87% probability, that policymakers will increase interest rates at that meeting. Meanwhile, the yield on 10-year Treasury notes has approached 3%, a level not seen in four years.

Higher interest rates will increase borrowing costs for corporations and consumers, while higher bond yields could curtail homebuying, a key driver of the U.S. economy. Even so, there’s nothing to suggest the economic expansion is at risk yet; rather, “2018 is shaping up as a year when we’ll see tension between economic strength and the policy reaction to that,” Gayle says.

What to watch: The interplay between the stock and bond markets, with investors of both varieties trying to predict the Federal Reserve’s next steps.

Stock market forecast

While the events of any one month can be interesting — and potentially significant for the market, as they were in February — if you’re invested in the market for the long haul, you shouldn’t stress about short-term disruptions or try to time swings in the market.

What’s more, the bull market is likely to continue through 2018. Strategists forecast the S&P 500 will end the year higher, according to the median estimate in a survey conducted by CNBC. Meanwhile, individual investors weren’t rattled by February’s volatility, as nearly 45% still expect stock prices will increase in the next six months, according to a weekly sentiment survey by the American Association of Individual Investors.

If you’re invested in the market for the long haul, you shouldn’t stress about short-term disruptions or try to time swings in the market.

After a year when the stock market seemed to move only one direction — up — it can be intimidating to buy when prices are in flux. Don’t let that deter you from participating in what’s proven to be a fantastic long-term investment. It’s normal for the market to go up and down and it will do so over the course of your investing timeline. One way to minimize the risk of a big shock to your portfolio is to ensure you’ve spread your money across a variety of assets.

Finally, if you can maintain your investing discipline, market dips like February’s can actually be advantageous for long-term investors. Dollar-cost averaging, which involves regularly adding money to your investments to help smooth out your purchase price, ensures you won’t dump all your money in when stock prices are at a peak.

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