12 Sept 2016
Get Ready for the US Market’s End of the Summer Slumber
The S&P 500 is largely flat through the month of August and volatility has been historically low; while trading volume has been depressed. That appears to be about to end as traders, investors and policymakers return to work and investors should be prepared. Complacency can be dangerous if investors allow their emotions to take control of their portfolio allocations during an uptick in volatility. With investor optimism reaching elevated levels according to a recent NDR Crowd Sentiment Poll, a near-term pullback is possible. We would view such an event as an opportunity to add to positions as needed, and likely a beneficial dip within the context of longer-term bull market. It does appear that the heavy outflows out of equity mutual funds and exchange-traded funds (ETFs) are slowing. ISI Evercore Research reported that outflows over the past year have totaled $115 billion—high, but down from the highest levels we saw earlier this year of $160 billion—an improving trend that could provide support for stocks.
Economic data perks up
The U.S. economy should support a continuing upward stock market trend. Although the second quarter real gross domestic product (GDP) number was quite weak, much of that was held down by a reduction in inventories, which should help growth this quarter as inventories are rebuilt. According to ISI Evercore, over the past five years real inventory accumulation has slowed by $127 billion. The last five times there was significant slowing in inventory accumulation real GDP growth rose by an average of 4.3% in the following year. We aren’t predicting a surge to that level of growth, but a replenishment of inventories could provide a tailwind to near-term growth.
In the meantime, we have seen some signs that manufacturing may be breaking out of its malaise. The hit from the drop in oil-related investments may be coming to an end as the price of oil has stabilized (for now) in the $40-50 dollar range; while the rig count has turned back up.
Additionally, the U.S. dollar, in contrast to many predictions following the Brexit vote, continues to trade below its 2015 highs, which has made U.S. goods more attractive to foreign buyers. However, the dollar has rallied a bit recently, so the tailwind may be limited. Railcar loading have also picked up a bit, the latest durable goods orders report was quite a bit better than expectations, and housing data continues to be encouraging.
The continued improvement in housing illustrates the healthier U.S. consumer and could start to help certain areas of the manufacturing sector. Existing home sales actually fell 3.2% in July, which seems to contradict the idea of an improving housing market; but the National Association of Realtors, which puts out the number, made sure to note the weakness wasn’t due to lack of demand, but rather a dearth of supply. In contrast, new home sales jumped 12.4% and moved to their highest level since October 2007.
A healthy U.S. consumer is vital to growth, and along with housing we continue to see signs of an improving picture in the labor market. The unemployment rate is a low 4.9% as 151,000 jobs were added in August according to the Department of Labor—slightly weaker than expected but still solid, and the forward-looking jobless claims number continues to trend near historically low levels. A tighter job market should continue to help pressure wages higher, which we’ve started to see, helping to increase the amount of disposable income available to consumers.
Fed focus continues
One thing that didn’t take a hiatus in August was the incessant dissection of every utterance from a Federal Reserve member. For those hoping for clarity, we surmise they were sorely disappointed. Various members offered conflicting views, and in one case the same member seemed to offer differing opinions in the same week about whether another rate hike is forthcoming. It may say something that there’s so much handwringing over a potential 25 basis point increase. If the U.S. economy can’t handle a 0.50% fed funds rate, we may be in more trouble than we think. Regardless, Fed Chairwoman Janet Yellen did sound a bit more hawkish in her comments from Jackson Hole, but Vice-Chairman Fischer seemed to steal the show when he mentioned the possibility of two rate hikes this year. We believe the momentum for at least one hike seems to be gaining ground.
Are investors about to start buying stocks again?
We are sympathetic to the Fed, however, as consistently predicting what markets and economies will do is hard, if not impossible. Predicting investor behavior, on the other hand, can be surprisingly simple. Without the aid of advice, investors often tend to chase returns. Decades of behavioral research suggest investors sell one investment to buy another that has performed better in the hope that the outperformance will continue.
Volatility is likely to pick up and investors should consider using volatility to tactically rebalance around longer-term strategic allocations. We believe a near-term pullback is possible but that the longer-term bull market is intact. Individual investors are showing signs of returning to the stock market and investor behavior analysis suggests that may continue to aid a continued upward trend.
This material is issued by Charles Schwab, Hong Kong, Ltd. The information provided here is for general informational purposes only and has not been reviewed by the Securities and Futures Commission in Hong Kong.