Bill Greiner, chief investment strategist, breaks down the current market in this month's market commentary.
Mar. 5, 2018 Commentary

Sing Along With Mitch


It’s back. After a long hiatus, stock price volatility has returned. The U.S. stock market has experienced its first 10+ percent decline in almost two years. Historically, in a typical year, stock prices tend to decline by an average of about 11 percent on an “intra-year” basis. We haven’t seen that kind of decline since the first quarter of 2016.

The Standard & Poor’s 500 index (S&P 500) declined by 10.1 percent over the nine trading days from Jan. 26 – Feb. 8, 2018. This decline is only part of the story of the increase in market volatility. From Jan. 26 to the close on Feb. 1, 2018, the market declined and the “intra-day” trading range (the high and low prices of the day) averaged 0.78 percent. Then, the Department of Labor released the January employment report. That was the catalyst which triggered the significant shift in market volatility.  

Following that report, from Feb. 2 (date of the report) until the close on Feb. 8, 2018, the market’s intra-day trading range averaged a change of 3.29 percent. This is a very wide spread, indicating a major upward shift in daily stock market volatility. On three of these five trading days, the S&P 500 price range was more than 4 percent…a very wide range, indicating fear had overtaken complacency on Wall Street.

What was in the employment report that justified this upward shift in price volatility? Not much. Labor costs rose to 2.9 percent year-over-year and from 2.5 percent the month before. This news shifted longer-term interest rates upwards, but not by much. Trading in certain volatility based products which take advantage of low-price volatility swooned to the downside, trapping some hedge fund and institutional managers on the wrong foot. This forced margin calls, which forced selling in the market. This is what some call a technical, not fundamental, correction.

Explanation – Keeping it Fundamental in Nature

Now that the global equity markets have suffered the first correction in prices, we suspect trading activity will take a new form going forward. Market price volatility should increase in 2018 as compared to the previous two years, due specifically to a change in Federal Reserve policy (no longer easing policy as far as the eye can see) and the important understanding of the risks that the new Fed policy regime will foster.

Higher interest rates (call it normalization) tends to bring anxiety to the markets as investors’ attitudes toward risk and valuation comes more clearly in focus. Stock market P/E ratios contract, and at times, fear enters the investors’ minds. Fear is overcome by the logical, more important questions, such as “Why are interest rates rising?”. Are interest rates and inflation rising solely because of supply shortages of some kind (labor/commodity), leading to a cost/push scenario? Or, are interest rates and inflation rising because of strong demand tendencies, leading to an upward shift in inflation…demand/pull?

One option is good inflation (demand/pull), which is accompanied by rising macro, final-demand trends, while the other (cost/push) simply puts pressure on corporate profit margins, lowering corporate profit growth rates. So far, the evidence is pointing towards rising risks of a demand/pull environment, which in a corporate profit standpoint, tends to be a positive issue.

Nonetheless, this new additive – rising interest rates and possible rising inflation – adds uncertainty to the market mix. This hasn’t been present for some time. This added uncertainty doesn’t necessarily lead to sustained lower stock prices, but does tend to lead towards more market volatility. This brings us to the title of today’s piece, Sing Along With Mitch.

Sing Along with Mitch – Or Follow the Bouncing Ball 

Mitch Miller was a recording industry executive who also hosted a television series in the early 1960’s called Sing Along With Mitch. The show featured Mitch Miller conducting a choral group singing popular songs. The words of the song were shown on the TV screen. A ball would “bounce” from one word to the other as the choir sang the song. The TV viewer had the ability to sing along, if they wished. The television show was very popular, and Mitch Miller produced numerous best-selling record albums with song sheets attached.

When I was a boy, I remember my family watching and participating with Sing Along With Mitch, particularly at family Christmas gatherings.

The increased volatility we may witness in market activity over the next days, weeks, or months, could be similar to following the ball while singing with Mitch. It may bounce up and down, but it won’t bound off the top of the screen, nor drop through the bottom. Volatility, if you will.  

Fundamentals Will Prevail

Market prices will always, eventually, be driven by fundamentals. Earnings (economic activity) and interest rates tend to be the two main factors driving asset valuations. We continue in the belief that corporate earnings growth will be strong this year. We expect to see $155 in earnings from the S&P 500, up more than 15 percent from the reported 2017 profits. This is powerful stuff. 

The other factor (interest rates and inflation) are the current wildcard. With the 10-year Treasury yield touching 2.9 percent on Feb. 26, 2018, rates have risen much more rapidly this year than most anticipated. Some fear the Fed is behind the curve, meaning their interest rate increases may be more rapid and aggressive than anticipated. Add a new Fed chairman into the mix and investor anxiety starts to boil.

At this time, we don’t believe inflation is going to get out-of-hand. Additionally, the type of inflation we will probably witness this year will be more demand/pull, which results primarily from an upward push in overall economic activity. We will see.

Our Bottom Line 

Interest rates have risen and will probably continue to push upwards. This is a symptom of a more mature economic cycle. Inflation should start to push upwards as well as labor costs start to rise, another symptom of a mature business cycle. Earnings growth this year should be very strong. Our advice…stay bullish and follow the bouncing ball.


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