30 July 2018
Summer Doldrums in U.S. Markets Have Yet Arrived, but Risks Remain
The traditional summer doldrums have yet to hit as the news flow continues to be heavy; however, significant up or down daily moves in U.S. stocks have been in a descending pattern since the February correction. Despite rising concerns surrounding trade, political wrangling, and Fed tightening, stocks are near the top of the recent trading range. Even with the move higher, however, we are becoming a bit more cautious and recommend that investors not chase the rally by moving out the risk spectrum; but remain patient, disciplined and diversified.
We remain in the secular bull market camp but maintain that any persistent upping of the antes by the United States and its trading partners with regard to tariffs and retaliations is a cyclical risk. One benefit of the trade uncertainty is that it’s allowed investor sentiment to move back into neutral territory from overly optimistic territory, according to the Ned Davis Research Crowd Sentiment Poll.
The latest round of proposed tariffs won’t go into effect until September at the earliest, leaving time for negotiations; however, there’s little indication that any serious negotiations are actually underway. President Trump again threatened to impose tariffs on cars and auto parts—which would represent a meaningful expansion of global trade tensions. Business (and consumer) confidence has held up in the United States; although the National Federation of Independent Business (NFIB) small business optimism index dipped in June (to a still-high level) and capital spending outlooks deteriorated within several regional Fed surveys.
Corporate earnings news fights for attention
Earnings season has not yet been given its traditional high billing in terms of investor attention. Consensus expectations were high coming into earnings season and there’s no reason to think companies won’t hurdle that bar; but what may be of more interest is the level of trade-related concern business leaders express; and the amount of capital spending and/or investment they may put on hold in the face of the that uncertainty.
More broadly, the Atlanta Fed’s GDPNow forecast for second quarter real gross domestic product (GDP) growth is at a lofty 4.5%; at the top end of the Blue Chip consensus range. In addition, for the first time in the history of the Job Openings and Labor Turnover Survey (JOLTS) (although the data only goes back to 2001), the number of available jobs is greater than the number people unemployed. Economic strength and the tightness of the labor market suggests some corporate spending can no longer be put off.
So far in second quarter earnings reporting season, results have largely been better than expected, with the “beat rate” running near 86%. However, like during the first quarter, beats have been only modestly rewarded, while misses have been more severely punished, further illustrating the high level of expectations coming in. As earnings season progresses, we will also be watching for mentions of cost increases to companies as they deal with higher wages, higher energy prices, and potential higher costs due to tariff increases.
No beach time for the Fed
If it makes you feel any better, the Fed has likely had little time to relax either, with their plans of a slow normalization facing questions from both the hawkish and dovish sides. In the release of the minutes from the most recent Federal Open Market Committee (FOMC) meeting, several officials expressed concern that the trade disputes could result in a slowdown of corporate activity—potentially putting in place a reason to consider reining in rate hikes. But with the aforementioned labor market tightness and upward pressure on inflation, market expectations remain high that we will see two additional rate hikes this year.
We agree with the consensus of two more hikes this year; but in his recent testimony before Congress, Fed Chairman Jerome Powell indicated the “autopilot” style of rate hikes are likely coming to an end. Incoming economic and inflation data will influence their actions to a greater degree, which could lead to more uncertainty regarding monetary policy for the remainder of this year.
Yield curve watch
Powell also expressed little concern about the yield curve—despite the elevated focus by investors and media pundits. Although every variety of yield curve has flattened this year, recession risk remains low for now. Even an inversion, which is likely coming, doesn’t necessarily signal impending doom for the stock market or economy—there are variable and sometimes fairly long lead times between inversions and trouble.
Market expectations and central bank expectations for the path of policy rates are not always aligned. In the past, the market has tended to be a more accurate gauge of policy action than the policymakers themselves, but it is certainly not infallible when it comes to forecasting.
Rising trade tensions are making us a bit more cautious, although the economic and earnings fundamentals remain healthy, which could cushion some of the blow from a trade war. Stay invested, but don’t reach too far out the risk spectrum, be prepared for bouts of volatility, and remain patient, diversified and disciplined.
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) Sentiment Poll shows perspective on a composite sentiment indicator designed to highlight short- to intermediate-term swings in investor psychology.
The NFIB Small Business Optimism Index is compiled from a survey that is conducted each month by the National Federation of Independent Business (NFIB) of its members.
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