Market Volatility – Understanding the Implications

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We have been fortunate to have enjoyed an extended period of calm in the markets for quite some time. Clearly that tranquility has broken with the volatility we have witnessed since the beginning of October. The question is whether this is a particularly pronounced correction, or the beginning of a longer-term trend?

What strikes us about this particular correction is both the depth of the volatility and the lack of consensus regarding the genesis of the correction – in other words, what’s causing this? The first concern gives all investors heartburn – significant daily volatility becomes challenging regardless of one’s time horizon.

But the second issue is more interesting from a strategic point of view. Historically, most long-term market declines are precipitated on events, triggered by large failures (Lehman Brothers), oil shocks, stock market collapses, geopolitical events (wars, terrorism), and the like. These events lead to significant downward periods of momentum, bear markets, and subsequent economic recessions. The link between the market and the economy during these periods of stress is pronounced.

Investors find comfort in assigning causation to the daily swings of the markets; look no further than the proliferation of the financial media for proof. Yet in this case, one struggles to find reliable and significant causation for the rapid volatility we’ve witnessed recently. Theories certainly abound, but one central root cause for our recent volatility is not widely accepted.

Rarely does the market diverge so strongly from the economic fundamentals that underpin the earnings and growth of the companies in which the public invest. As you will see in the accompanying “Third Quarter Review”, the US economy is picking up momentum and performing much better than it has in quite some time, as measured by a multitude of metrics.

We are not economists, nor do we attempt to predict the future. We offer our insights only to suggest investors have enjoyed meaningful returns amid largely peaceful periods of low volatility for several years; market corrections are common, and we have gone quite some time without one.

Given the lack of any significant underlying cause to the recent spike in volatility, our initial estimate is this is a market correction, like many others before, and not the beginning of a prolonged bear market.

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