Hello volatility my old friend…

As was surely inevitable, volatility has returned to the markets after an historically quiescent couple of years. As this is being written, markets in Europe are down nearly 5% after a similar drop in the US on Monday.

What should we make of this and what, if anything, should we do?

The answer to the first question is that it’s not possible to point to any simple explanation, notwithstanding the fact that your newspaper this morning is bound to be filled with articles declaring that rising inflation and interest rates are the culprit. Maybe, but things in economics are rarely as simple as that and besides, markets have flourished in the past with interest and inflation at much higher levels than today. The short-term answer is the less precise but more accurate villain known as sentiment. Markets are social constructs and, like a school of fish suddenly banking in unison and setting off in a new direction, investors often follow a new trend en mass with no precise trigger to point to. Not that we’re saying one day (or even two or three) constitute a trend.

What we do know is that the pace of economic growth has been ticking up worldwide this past year in a demonstration of synchronized advance the likes of which haven’t been seen in years. The rest of the world is still playing catch up to the US, both in terms of duration of recovery and market valuations. If US markets decide to take a breather, they’ll depress everything else for a while (sentiment knows no boundaries) but underlying realities will ultimately rule the day. And the ultimate underlying reality is that the US and world economies are always biased toward growth, even if they take the occasional breather.

As for the second question above, to the degree we’re likely to see a continuing rise in interest and inflation rates, we factored that in some months ago when we shifted all of our bond allocations to ultra-short maturities, leaving them insensitive to rising rates. Beyond that, a continuing commitment to rebalancing and cash management is the order of the day. That discipline led us to take considerable funds “off the table” over the past six months and will continue to serve us going forward.

So, we’ll all watch the markets with interest in the coming days (or not, it’s certainly not required) and read the daily stream of opinion with a skeptical eye. In the meanwhile, be well!