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What you need to know about the stock market roller coaster

SPONSORED — Whether it’s in love or in the stock market, falling hard is never easy. And for investors, Jan. 30 through Feb. 5 was a rough tumble. If you were surprised by this, don’t feel bad; even your fund managers were caught off guard. As referenced in the Merrill Lynch Global Fund Manager Survey, fund managers anticipated continued equity growth throughout 2018 and planned to stay long in equities until inflation impacted corporate earnings.

That hasn’t happened yet. According to John Butters of FactSet, “of the nearly 400 S&P 500 companies that have reported results for Q4 2017, 75 percent have beat on profits and 78 percent beat sales estimates.” Historically, this indicates a strong market.

The cause

Those very fears of rising inflation may be to blame for the market upheaval we saw last month. With higher inflation causing higher borrowing costs, large banks began reducing their positions in equities because of this perceived risk.

“The big banks wanted to lock in their profits,” explained Ken Peterson of Online Trading Academy. “The huge rush into the market by retail investors gave the banks the opportunity to begin to liquidate. The last week of January saw investors, surprisingly, rapidly following suit, with about twice the normal cash flowing out of the market as is customary prior to a prolonged period of low or negative growth as was experienced in the first three quarters of 2015.”

The new ‘wall of worry’

Banks, investors and mutual funds were all quick to drive stock prices back up.

“This was a V-shaped recovery,” Peterson said. “Greed took over. AMZN was trading for $1,265, down $230 per share from just two weeks earlier. AAPL was trading for $150, down $30. NVDA was down $45, MSFT, GOOG and FB all off 15 percent of more.”

That recovery doesn’t mean investors are out of the woods.

“Seasoned investors will be watching for the retests of the lows,” said Quincy Krosby, chief market strategist at Prudential Financial. “For now, we just added a new wall of worry to climb and that is inflation.”

Expert opinions

After a market ride like this, the Merrill Lynch Fund Manager Survey is not surprising: Seventy percent of fund managers are now expecting a recession. That said, Krosby, for one, is exhibiting a more positive outlook.

“Importantly, we do not believe that the very strong global growth and earnings backdrop has suddenly evaporated,” he said.

Ken Peterson agrees.

“I don’t believe a recession is around the corner,” he said. “It is reasonable to expect, however, the markets to retest the lows. Why? Cause that is often what happens in V-shaped recoveries. There is a reason why banks took profits in January. As price returns to those levels, they will again. If the general public continues to be skittish and sell at the first sign of trouble (often the case with late money), we will relive this experience again in a week or two.”

The strategy

According to Krosby, there’s a bright side to all this volatility.

“We’re in a situation where the Fed is actively trying to reduce their balance sheet by selling bonds at the same time when the government will need to borrow more than a trillion dollars to finance the deficit. Yields will have to go higher,” he said. “Markets will be fine with higher yields and higher inflation as long as the economy is solidly expanding and companies are able to pass on the price hikes onto the consumers.”

For Peterson, the market roller coaster is particularly lucrative for traders.

“Now do you see the advantage of trading in the markets rather than buying and holding,” he said. “Traders did well the past couple weeks. And they will again in the next few while investors either worry or panic and sell taking losses.”

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