February 8, 2018 saw a 1000+ point loss on the Dow Jones Industrial Average1 (-4.15%), along with a 100+ point loss (-3.75%) for the S&P® 500 Index.2This downturn officially put the US stock market in correction territory ? typically defined as a 10% or greater sell-off from its peak. Since their respective peaks on December 26, 2017, the Dow is off 10.4% and the S&P 500 is off 10.2% (in price terms). Similar pain has been inflicted on non-US equity markets, as well.

What do we make of this market rout and recent extreme volatility? Here are some thoughts:

No element of surprise
First, despite the growing strength in the global economy and earnings forecasts, it seems equity markets had clearly gotten ahead of themselves. After an already strong year, the ascent of the US market became extreme in December and January. With valuations already stretched, and investor sentiment surging, global equity markets appeared priced to economic perfection. In other words, priced to highly optimistic expectations for future earnings. While the timing is always unknown, to some degree, this correction should have been expected.

Inflation, rate hike fears trigger cascading volatility
Second, no one can say for sure what the exact cause of the sell-off is. As we noted above, the market had become frothy, but that shouldn?t trigger a sell-off by itself. What was the catalyst? We believe the closest explanation is that the strength in the global economy is finally creating some fears of inflation, tighter monetary policy, and higher interest rates. In simpler terms, investors may be worried the economy is overheating. As the market began to experience these initial losses, the super-low volatility regime that had been in place for some 14 months cracked. Measures of both implied and realized volatility jumped. This increased volatility cascaded into any number of ?volatility managed? products that are typically utilized to help de-risk (i.e., sell some of their holdings) when markets get more turbulent. This forced selling, and knee-jerk buying on lower prices, likely helped to create early-February?s peaks and valley.

Correction contained to stock market
Third, we take some comfort in the fact that most of the damage has been confined to equity markets. During the week of February 5, the CBOE Volatility Index (the VIX)3 was elevated ? but not to extremes. There has been no flight-to-quality rush into gold or into the US dollar, and credit spreads have only been modestly affected. The stock market may be in full-blow panic mode, but most of the other asset classes aren?t listening yet, which could be a sign that a larger meltdown isn?t imminent.

Global growth story appears intact
Fourth, we concede that there is a risk the economy may overheat ? especially in the US where unemployment is already low and deficit spending is about to skyrocket. However, we fundamentally still believe in the global growth story. Over time, earnings growth should keep stocks on an upward, if uneven, trajectory. We don?t think investors should expect runaway gains as gradually rising rates will keep price/earnings ratios4 in check. While inflation pressures are beginning to appear in spots, we will need a lot more evidence of rising wages and prices before we can conclude that central banks are falling behind the curve.

Market turbulence may linger
Finally, in spite of our continued confidence in the economy, we cannot know when the stock market will return to a more normal trading pattern. Our hope is that at current index levels, the markets have already forfeited the oversized gains from the last two months and will soon regain some stability. However, to the extent that market drawdowns may have been caused by systematic de-risking in various strategies, recent market turbulence could last longer. These strategies all assess and react to changing volatility at different time horizons (short, medium, and long-term) and at different frequencies (hourly, daily, monthly, etc.).

Markets may continue to reverberate for a bit longer. Regardless of the market’s future direction, we do believe the era of super-low volatility is over. Investors would be wise to reassess their risk tolerance, their portfolios, and their expectations in this new world of uncertainty.

1 Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq.

2 S&P 500® Index is a widely recognized measure of U.S. stock market performance. It is an unmanaged index of 500 common stocks chosen for market size, liquidity, and industry group representation, among other factors. It also measures the performance of the large cap segment of the US equities market.

3 The CBOE Volatility Index (the VIX) measures expected future (30-day) volatility of the S&P 500® Index and is derived from the prices of S&P 500® Index options. An option is a contract that gives its owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time.

4 The price/earnings ratio (P/E ratio) is the ratio of a company?s stock price to the company?s earnings per share. The ratio is used in valuing companies.

Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and are as of February 9, 2018. There can be no assurance that developments will transpire as forecasted, and actual results may vary. Other industry analysts and investment personnel may have different views and make different assumptions. Accuracy of data is not guaranteed, but represents best judgment, as derived from a variety of sources. The information is subject to change at any time without notice.

CFA® and Chartered Financial Analyst® are registered trademarks owned by the CFA Institute.

This document may contain references to third party copyrights, indexes, and trademarks, each of which is the property of its respective owner. Such owner is not affiliated with Natixis Investment Managers or any of its related or affiliated companies (collectively ?Natixis?) and does not sponsor, endorse or participate in the provision of any Natixis services, funds or other financial products. The index information contained herein is derived from third parties and is provided on an ?as is? basis. The user of this information assumes the entire risk of use of this information. Each of the third party entities involved in compiling, computing or creating index information, disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to such information.