As many of you are aware, equity market volatility increased substantially over the last three trading sessions with the S&P 500 down (6.07%) in August. During times of market stress, putting short-term volatility in the context of longer-term results may be important and drive better decision making.

Let’s look at the various facts that are driving the current market volatility. The Federal Reserve, in its effort to reduce inflation, raised the Fed Funds target rate to a range of 5.25%-5.5%. This rate has been in effect since July 2023, but the campaign to raise rates began in earnest in March 2022. By all accounts, this effort was successful as we have observed inflation, as measured by CPI, move from a high of 9.1% year-over-year in June 2022 to our most recent reading of 3.0%. 

However, this policy path intentionally and undeniably slowed the economy, with abundant data to support such a conclusion. The ISM Services Purchasing Managers Index, or PMI, is a measure of economic activity based on regular surveys sent to purchasing and supply executives at more than 400 services companies. Readings above 50% suggest an expanding economy, while readings below 50% indicate a contracting economy. The PMI is often referred to as a leading economic indicator meaning that it may be used as a measurable set of data that may help forecast future economic activity. Looking back to the data from when the Fed began raising interest rates, the peak of the ISM Services PMI was 58.3 in March 2022. In April of this year, we saw the first print below 50 with a reading of 49.4. In contrast, May came in at 53.8. Subsequently, the monthly data variability has continued with June at 48.8 and this morning at 51.4. This data is anything but conclusive to suggest we are heading toward a recession, but the path lower has been clear.

Additionally, and arguably reported more frequently in the media, the labor market is weakening. Both initial and continuing jobless claims increased, a rise in the unemployment rate to 4.3%, and slower nonfarm payroll growth – all clear signs of a weaking labor market. Average Hourly Earnings, a measure of year-over-year change in worker compensation, was substantially higher than long-term averages emerging out of COVID and, to reduce inflation, the Fed needed to reduce the change in AHE. This was successful, even though a known side effect was weakening the labor market. We would also suggest that unemployment is a lagging economic indicator; while important to monitor, it is often based on something that already occurred.

The economy is clearly slowing. The current market debate is whether the Federal Reserve is behind and has kept the Fed Funds rate too high for too long. From our perspective, a critique of the Federal Reserve is too early based on the data. The Fed Funds interest rate probabilities, a measure of the expected path of future policy changes derived from current market positioning, is pricing in an interest rate cut of 50 basis points at the September 18^th meeting. 

From an equity market perspective, the breadth of this market from January through the end of June of this year was exceptionally narrow. The largest stocks were driving nearly all of the performance. If one compares the return of the S&P 500; (a market cap weighted index); to that of the same index but applying an equal-weight methodology, the S&P 500 Market-Cap Index was +19% vs the S&P 500 Equal-Weight Index +5.65% from January 1^st – July 10^th of this year, a difference of 13.35%. When looking at this same data set over the last 20 years, the annual difference has been less than .25% annually. From a market technical perspective, this was unhealthy. We did begin to see some breadth widening since mid-July, as that difference recently narrowed to 6.27%.

Market corrections are both normal and healthy, though we appreciate they are less than enjoyable to endure. There is no universally accepted definition of a correction, but most people consider a correction to have occurred when a major stock index declines by more than 10%, but less than 20%, from its most recent peak. Historically, most corrections did not become bear markets. Since the 1970s, there have been about 5x as many market corrections as bear markets. Additionally, pullbacks within a bull market are normal. Over longer periods of time, pullbacks of 10% or more tend to occur about 50% of the time, or once every other year. Additionally, this market action seems decidedly healthy as the stocks that meaningfully outperformed over the past year or so are the ones seeing the largest drawdowns. We are often reminded of a quote by the now late Ben Graham, “In the short run, the stock market is a voting machine. Yet, in the long run, it is a weighing machine.” The message implies that short-term results may be driven by hype and sentiment, but longer-term results are driven by measured and concrete financial results.

So, what should one do? During times of market stress, we believe adopting a strategic view is the best course of action. From October 27, 2023, through mid-July, the S&P 500 was up over 39%, trough to peak. On an annualized basis, this is over 58%. Even through market-action today, the S&P 500 is up more than 27% since October and more than 8.7% YTD. Stock market performance is not linear, and we should not expect it to be, despite how much we desire that to be the case. Unless your financial situation has changed, we would suggest remaining invested. 

Our approach to seeking stocks that exhibit Quality characteristics is a timeless approach to market investing. These names may not always participate fully in the upside during times of irrational exuberance, but such names often outperform during times of market stress. From an asset allocation perspective, times of volatility reinforce our approach to gain exposure to risk assets through both the public and private markets. Private market investments are less subject to the swings in short-term sentiment that is often witnessed in the public markets, making them a core component of return drivers for portfolios seeking to drive portfolio alpha for those clients than can allow for some of level of illiquidity within their portfolio.

The team at TritonPoint Wealth is here to help. Should you have any questions about this information and how it relates to your personal financial situation, please do not hesitate to reach out to your advisor.