Markets Tumble

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Not the Beginning of the End

From the recent record high on the S&P 500 Index achieved January 26 through market open this morning, U.S. equity prices have fallen almost 5%. While that’s still less than half of the commonly accepted definition of a “correction”, a 10% retreat, it’s nonetheless the sharpest pullback we’ve seen in almost two years, eclipsing by a hair the drawdown observed heading into the Election in the fall of 2016. So, is this the start of a more pronounced decline? That undoubtedly remains a possibility, but we are skeptical that this is the end of the long bull market. We see an opportunity to add incrementally to equity positions at this level, and we will continue to add risk to our portfolios, should the pullback deepen further.

The Inflation Boogeyman Makes an Appearance

The very phrase “correction” implies that stocks are mispriced and due to be reset. That may well apply here. Market pricing has been on a tear post-Election, with nary a pause along the way, particularly in January of this year. While underlying economic fundamentals have been strong and are getting stronger, and while tax cut legislation presents a further boon to corporate earnings, a growing number of investors were likely uncomfortable with the pace of price gains over the past year. Any sign of distress is sufficient for some to pull a few chips off the table under such conditions, and last week, they were given that sign.

The Bureau of Labor Statistics reported on Friday that wages earned by workers paid hourly climbed 2.9% year over year, the highest such reading since 2009 (although only marginally higher than the 2.8% figure recorded in September that failed to provoke a similar market response). Wage inflation has historically engendered broader price inflation – when workers are getting paid more for doing the same job, prices on all goods tend to rise, as there is more money in circulation without a commensurate increase in the quantity of goods and services available for sale.

So, why is inflation so concerning to equity investors? Several reasons. Firstly, future earnings must be discounted back to present value at a higher rate, implying a lower value in today’s dollars. Also, as bond yields are pushed higher along with inflation, the relative value of stocks versus bonds declines. But most importantly, rising inflation forces central banks to tighten monetary conditions, choking off economic growth and precipitating recession. There seems to be some concern that an overheating economy may be closer at hand than realized. With unemployment already quite low, fiscal stimulus from tax cuts and a potential infrastructure bill may drive wage and price gains to worrisome levels.

Cycle Peak Not Yet in Sight

That may be so, but not at any point on the visible horizon. Inflation is rising, but remains at an entirely benign level today. Likewise, the Fed has been gradually withdrawing monetary accommodation for the past two years, but financial conditions remain exceptionally easy. Companies are indeed paying their workers more, but at the same time, they are investing aggressively in productivity-enhancing software and equipment. As long as productivity is rising (i.e., more goods and services are available for sale per man-hour worked), then companies can pay higher wages without dramatically increasing prices on their products. Runaway inflation is not a clear and present danger by any stretch.

A recession lies in our future – that much is an incontrovertible truth. But, it is a distant future. There is ample reason to believe that economic growth, and corporate profits with it, will be exceptionally strong this year and most likely next year also. Stock prices are a little high, but not exorbitantly so, and investor enthusiasm remains elevated, despite this current hiccup. We are buyers at these levels, and we’ll come in more aggressively, should prices continue to fall, as we have every expectation that the market is going to achieve new highs within a few months.

The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are as of the date of this report, are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in this material will be realized.

About Risk

All investments are subject to market risk, including possible loss of principal. Stocks and bonds can decline due to adverse issuer, market, regulatory, or economic developments. Bonds are also subject to credit risk, in which the bond issuer may fail to pay interest and principal in a timely manner, or that negative perception of the issuer’s ability to make such payments may cause the price of that bond to decline. A bond’s prices are inversely affected by interest rates. The price will go up when interest rates fall and go down as interest rates rise.

S&P 500 Index is an index of 505 stocks issued by 500 large companies with market capitalizations of at least $6.1 billion.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, NJ 07302.

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Jonathan Swaney

Managing Director and Senior Portfolio Manager, MainStay Investments

Jon is a Managing Director and Senior Portfolio Manager in the Strategic Asset Allocation & Solutions Group.  His current focus is on management of the MainStay and third party asset allocation strategies

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