Volatility Jumps, But It’s Still a Bull Market

The stock market has taken investors on a wild ride in recent days, but Mike Wilson, Morgan Stanley’s chief investment officer and chief U.S. equity strategist, doesn’t think the sudden spike in volatility portends the start of a bear market. 

Sharp downdrafts last Friday and this Monday were followed by a rebound on Tuesday. The actual move in markets through the close Tuesday represents a normal correction—even though it happened a lot faster than normal, Wilson says.

“I just want to remind people that in the last 12 months the S&P 500 went up 20%,” he says. “It has had a heck of a run. It doesn’t surprise me that we have had a little volatility here.” A correction is a market drop of at least 10%. On average, the market corrects 14% in a year; last year, the biggest correction was just 3%, says Wilson. “People get used to that,” he says. “They start to count on that. So when volatility picks up, it can lead to forced selling.”

Strong corporate earnings growth and global synchronous expansion have fueled the past two years’ rally and that dynamic is still in place even if market valuations got stretched, says Wilson. A rise in interest rates—in part related to tax cuts which will stimulate the economy and require the government to issue more debt—caused many investors to revalue their stock holdings (equities are often valued in part based on their expected returns versus a risk-free Treasury). Technical factors also contributed to the size of Monday’s selloff, says Wilson. 

Non-U.S. markets also followed the U.S.’ lead and sold off, too, which Wilson thinks created “a lot of value in global equity markets.” For investors with cash on hand, he thinks it is appropriate to start easing back into the market, but not all at once as the recent market turbulence may well last a few more weeks. “Recognize that volatility is going to stay high and the market is going to be choppier,” he says.

So far, Wilson says the bull market is clearly a mature one, but he doesn’t see signs that a bear market is approaching soon. Still, he is keeping a close eye on financial conditions. Below are three signals he’s watching to stay ahead of a market shift:

• If the yield, on the benchmark 10-year U.S. Treasury note rises to 3.25% or 3.50%, “that could cause a real problem,” he says. It’s now 2.8%.
• If corporate bonds start to trade very poorly and credit spreads start to widen out. So far, “credit has traded weaker, but nothing significant,” he says.
  
• If highly speculative investments, like cryptocurrencies, continue to fall and don’t rebound. 

Wilson recommends investors emphasize international over domestic equities and upgrade their bond portfolios, avoiding high yield. He advocates for balancing growth and value stocks and suggests adding stocks in defensive sectors, such as utilities. 

“There is still plenty of opportunity,” says Wilson. “We’re not at the end of the cycle, but it is time to be vigilant and more tactical.”