After a long stretch of benign financial market activity, equity investors have been jolted to attention as if bitten by a rabid dog. Daily swings in the S&P 500 of more than 1% have occurred in eight of the last twelve trading days (as of October 14, 2014) after going more than 60 days without a single incident. Since the beginning of October, the average daily price swing in the Dow Jones Industrial Average has been more than 250 points. The wild price fluctuations have been enough to trigger heartburn in even the most casual market observer.

All of this volatility would be fine if the end result were higher prices, but the opposite has been true. The S&P 500 has fallen more than 7% since the high set in mid- September, trimming its year-to-date gain to 1.4%. The Dow has now slipped into negative territory for the year. Other asset classes have fared far worse: European stocks are down 11%, oil has fallen to $85 per barrel (down 13% this year), and U.S. small cap stocks are down about 10%.

As noted in past Perspectives, the long absence of a significant market pullback has resulted in increasing complacency of many investors. It has been more than three years since the S&P 500 experienced a 10% decline and the start of the painful 2008-2009 market collapse is now six years behind us. With little recent experience to steel investors against the inevitable peaks and valleys of stock prices, the fear factor has set in.

So is this the start of the major “market correction” that some strategists have been warning about (some, for years) or is this just another opportunity to buy the dip? While no one can say for sure, an examination of the causes of the current decline may provide some clues. The most commonly cited cause for the sudden weakness has been a spate of negative economic news coming from overseas, especially Europe. With inflation almost non-existent, interest rates near zero, and economic growth flagging, investors are worried about a long period of economic stagnation in Europe that could weaken the U.S. growth story. Add to that the surprising decline in energy prices (interpreted as a sign of weakening global demand), continuing turmoil in the Middle East, the Fed’s plan to raise interest rates next year, and the looming Ebola threat, and you have a recipe for high anxiety.

We believe that none of these factors should be impactful enough to cause a major (20% or more) market decline. Most major corrections in the past 30 years have been accompanied by a sharp spike in energy prices along with aggressive moves by the Fed to raise interest rates in order to stave off inflationary pressure. None of those risks are present now. As noted, energy prices are falling sharply and inflation is below the Fed’s target of 2%. The Fed has never raised rates when inflation is falling and oil prices are trending down. We believe the continued benefits of low interest rates and energy prices trump the negative signals that weakening prices sometimes engender.

In our view, the underlying economic story and the case for equities remain intact. While the fear factor may take some time to dissipate, we continue to believe the long-term outlook remains bright.

Investment and Insurance Products: 
• Are Not insured by the FDIC or any other federal government agency 
• Are Not deposits of or guaranteed by a Bank or any Bank Affiliate 
• May Lose Value


The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed.

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as on the date of this document and are subject to change.

This material is available to advisory and sub-advised clients of City National Rochdale, LLC, a Registered Investment Advisor and a wholly owned subsidiary of City National Bank.