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More Violent Moves in the U.S. Equities due to the Increasing Market Noise

Stocks have pulled back from the top of the range, and volatility has increased. Risks of a damaging trade war have risen. If the confidence of consumers or businesses is shaken, the potential for spending and capital investment to level off or decline grows, which could lead to a short-circuiting of the economic expansion and/or bull market. 

Contentious trade negotiations have occurred in the past, but the fact that they’re being played out so publicly is a new phenomenon—resulting in rising trade-related market volatility. Although markets are clearly reacting to the day-to-day trade news, investors should refrain from trying to trade around the volatility.

As noted, trade isn’t the only cause for concern, as a rising dollar, slowing global economic growth and the possibility of a central bank mistake all appear to be impacting sentiment. We’ve seen stocks with greater international exposure—such as those in the technology and industrial sectors—get hit over the past couple of weeks as trade policy and a rising dollar—which makes U.S. goods more expensive to foreign buyers—have weighed on the sectors.

Cutting through the noise

While concerns have risen, the bull market is likely intact. Corporate cash remains ample, with more being repatriated, as evidenced by the Bureau of Economic Analysis (BEA) report highlighting that $308 billion was repatriated in the first quarter; helping lead to a record $189.1 billion in stock buybacks. And there is still plenty more to bring back, with the tax reform making it more advantageous to do so. Additionally, while CNBC reported that two-thirds of corporate CFOs were concerned that the escalating trade disputes would negatively impact their businesses, business and consumer confidence remains healthy.

The recent market volatility has resulted in investor sentiment, a traditionally contrarian indicator, pulling back to neutral according to the Ned Davis Research Crowd Sentiment Poll. In addition, SentimenTrader’s “Smart Money/Dumb Money Confidence” measures of behavioral sentiment show “smart money” optimism rising (the non-contrarian indicator), while “dumb money” optimism is fading rapidly (the contrarian indicator).

Through the noise

For now, the U.S. economy is in good shape to withstand some trade-related headwinds, but the second-order effects need to be monitored as well. There remains an ongoing tailwind from tax reform, especially for the consumer, while job growth remains strong. The latest jobs report from the Bureau of Labor Statistics (BLS) showed that 213,000 jobs were created and the unemployment rate ticked higher to a still low 4.0%, largely due to an increase of 602,000 workers in the past month to the labor force.

Monetary policy more than just noise

Also out with the labor report was the average hourly earnings number, which advanced a very modest 2.7%, continuing a trend of low wage pressures. While this will likely do little to dissuade the Federal Reserve from continuing its rate-hiking campaign, it won’t likely add to safety concerns for a group that has yet to express much concern over rising inflation—with multiple references by Federal Open Market Committee (FOMC) members about accepting of a little “heat” on the inflation front so as not to short-circuit the economic expansion. However, concerns are growing that the Federal Reserve could make a policy error and cause an inversion of the yield curve given the retreat since May in the 10-year Treasury yield.

The yield curve has historically been a good indicator of a coming recession when it inverts—the shorter end moving above the longer end. For now we remain confident that the Fed has little desire to tempt fate and invert the curve purposely. But even absent an inversion in the curve, financial conditions are tightening and global liquidity is receding—both of which have implications for the economy and markets.

So what?

The noise surrounding the stock market is getting louder, resulting in more violent moves in equities. Much of the sound and fury is best ignored by long-term investors, but there are growing risks to the bull market in the form of rising trade disputes and the possibility of a central bank mistake. For now, we believe the secular bull market is intact, but are growing more concerned and urge investors to remain disciplined and diversified. 

 

Important Disclosure

Investment involves risk. Past performance is no indication of future results, and values fluctuate. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market, economic or political conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Diversification and rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.

Past performance is no guarantee of future results. Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.

Ned Davis Research (NDR) Crowd Sentiment Poll shows perspective on a composite sentiment indicator designed to highlight short- to intermediate-term swings in investor psychology.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

About the author:
Liz Ann Sonder, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
Jeffrey Kleintop, Senior Vice President and Chief Global Investment Strategist
Brad Sorensen, CFA, Director of Market and Sector Analysis, Schwab Center for Financial Research

Content provided by Charles Schwab, Hong Kong
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