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Risks are Rising Along With U.S. Stocks

The U.S. bull market continues but there are warning signs that near-term pullbacks are becoming more likely. Perhaps the most telling quote over the past couple of weeks was Target’s CEO telling CNBC that, “We’re benefitting from a very strong consumer environment—perhaps the strongest I’ve seen in my career.” While positive, it’s that sentiment that gives us pause as it’s begun to carry over into investor sentiment—and at extremes, they can be contrarian market indicators. Although U.S. stocks recently hit an all-time high, leadership groups have continued to be more defensive in nature. Telecom and health care have outperformed over the past month, while more cyclical groups like industrials, materials and energy have underperformed.

Consumer spending and confidence remain robust, but a risk to watch is the deterioration in a number of housing indicators. New home sales fell 1.7% in July to a nine-month low after a 2.4% drop in June according to the Commerce Department; while existing home sales fell 0.7% in July according to the National Association of Realtors, to the lowest rate since February 2016.

With stimulus from tax cuts likely to fade over the coming quarters (if only due to tougher year-over-year comparisons), investors need to be mindful of an expectations bar that gets set too high. And while good in general for the U.S. consumer, we’ve seen the stronger dollar cause some problems in a few emerging market countries that hold debt in U.S. dollars—a trend that could worsen should the dollar resume its strengthening trend.

Lastly, we don’t want to ignore “Dr. Copper.” Long hailed as a “tell” for world economic growth, the metal has struggled lately. There are extenuating factors which explain some of the weakness, such as the stronger dollar and supply issues, but we should not ignore the message it may be sending.

The Unknowns—the Fed and trade

Trade rhetoric calmed down a bit recently, with the United States and Mexico announcing an agreement in principle, with Canada entering the discussion. However, recent talks with China apparently went nowhere (more on that in a moment). As such, we could continue to see rallies on positive trade developments, but also pullbacks on the opposite side. Best case scenario is that trade agreements which feature more free trade will be made; but how much pain there is between now and then remains in question.

The Fed didn’t miss out on the end-of-summer fun, with its annual Jackson Hole getaway. There weren’t a lot of surprises which came out of Wyoming, but the minutes from the Fed’s last meeting indicated that the September meeting is assuredly on the table for another rate hike. The futures market currently places more than 50-50 odds of another hike this year—likely in December—but the data-dependent nature of forward expectations means those odds are likely to ebb and flow. The minutes noted that it may be appropriate soon to remove the “accommodative” language from their description of monetary policy—especially given that inflation is now at or above the Fed’s target—while also noting that trade remains a paramount concern as it relates to business investment plans. That uncertainty could result in more stock market volatility as investors worry that the Fed may move too far in its normalization campaign.

So what?

The U.S. equity bull market is intact, but recent action has not been fully-convincing, and we believe risks are rising, especially if we begin to see the same kind of frothy investor sentiment which accompanied the January highs. We continue to push the merits of tried-and-true disciplines like asset class diversification and rebalancing—the latter which forces investors to do what we all know we’re supposed to do, which is buy (or add) low and sell (or trim) high. As the old adage goes, “bulls make money, bears make money, but pigs get slaughtered.”

 

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.

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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