Quick Thoughts: On the US Markets and Volatility

Stephen Dover, Head of the Franklin Templeton Investment Institute, recently sat down with colleagues Scott Glasser, Chief Investment Officer of ClearBridge Investments, and Mark Lindbloom, Portfolio Manager for Western Asset, to discuss recent US market volatility.

Volatility Is to Be Expected

We are emerging from a period of unprecedented fiscal and monetary stimulus which flooded the markets with liquidity. Now this liquidity is slowly being withdrawn, as the Federal Reserve (Fed) seeks to combat inflation. Considering this, in conjunction with a once-in-a-generation global pandemic, and volatility is understood, if not expected. Equities, most notably growth stocks like those in the Nasdaq, are long duration assets. As such, they tend to be extremely sensitive to changes in liquidity. This market is probably as long in duration as any we have seen since the early 2000s.

A Transition to the “Old Normal”

As we move from a period of low inflation and excess liquidity to one with modest or higher inflation and less liquidity due to central bank tightening, we view this as a normalization of market conditions—a return to the “old normal” so to speak—with more regular periods of volatility. We may have forgotten that it is typical to have 10% corrections periodically. Volatility is a completely normal aspect of a healthy market as it allows for rotating leadership in terms of sectors, market capitalization, geography, and valuation.

This Isn’t the Inflation of the ’70s

Finally, as we look at what is happening with inflation today, it is important to recognize this is not the inflation of the 1970s. First and foremost, the current Fed is resolute in its intent to do what it takes to fight inflation, which was not the case until 1979 when Paul Volcker was appointed Fed chair.