"Trade Woes" or "Reversion to the Mean"?

May 13, 2019

 

As of 3:00pm today the US markets are down 2.5% to 3% on the news that the tariffs and global trade concerns may not be drawing to a close this week, as previously anticipated by the Trump administration. Interestingly, most Wall Street economist's believe that the trade negotiations will likely take many years to actually come to a resolution. So, why the big market sell off on news that most of Wall Street already expected would play out?

 

Perhaps the real reason for today’s market pullback is something altogether different. I would submit that the real issue is profit taking. Most people don’t realize how much the S&P 500 rallied from December 26 until last Friday, pushing its value near an all time high. From an investor’s perspective, anytime have we a significant rally over a short period of time, it becomes very logical to take some profits.

 

We live in a world where the valuations of financial instruments are bound by a statistical concept called “reversion to the mean.” In market cycles when assets get too expensive too quick, it creates more pressure on disciplined investors to take profits. Then, when more sellers are present than there are buyers, the law of supply and demand forces prices to go down.

 

This same reversion occurs after large selloffs in the market. Most stocks and bonds can become oversold when market sentiment is so negative that investors begin selling out of fear of enduring larger losses. However, in the midst of those fear induced cycles, reversion to the mean is the very reason that sparks disciplined investor to begin buying discounted investment assets.

 

Fortunately, we have had the privilege to work with most of our clients for years or even decades, so market volatility seems normal to us. This round of excitement does have a new twist in that we are dealing with a foreign relations issue with China. But ultimately today’s headlines will be yesterday’s forgotten news and investors will return their focus to the strength of our American economy and the ability of our companies to continue to have robust earnings.

 

BOTTOM LINE: While people try to blame China, or Trump, or global trade for today’s sell-off, it’s more likely that this is simple profit taking from the markets rally over the past 4 months. Try not to get too excited about these short term market movements. Our economy is still moving in the right direction.

 

We continue to monitor market movements looking for opportunities to help our clients build wealth while limiting risk. Feel free to reach out if you have any specific questions or concerns about your accounts.

 

Thank you for the continued opportunity to serve you and your family.

Lyn

 

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