26 Aug 2019
The U.S. Equities Could Remain Volatile with Market and Economic Uncertainty Mounting
U.S. equity indexes have recently experienced some wild swings and an uptick in volatility—yet they have also shown some resilience, potentially misleading investors that the recent economic downturn is simply a blip. Increased trade tensions with China via another threatened tranche of tariffs (although partially delayed); Beijing’s decisions to halt agricultural purchases from the United States, let the renminbi fall relative to the dollar, and threaten additional retaliations; inverted yield curves; have all contributed to growing consternation among investors.
Volatility has increased as yields have fallen and the inversion has deepened
Adding to the worrisome mix are apparent increasing concerns regarding the slowdown in economic growth. Should it be the case that the United States is imminently heading into a recession, it’s possible we may already be in one, given that recessions are dated near the peak in economic activity.
Lost in the day-to-day trade-related volatility are longer-term concerns. Trade is not the only culprit behind weak global growth. Protectionism has been growing as a global force—predating the start to the trade war—while significant demographic hurdles and the negative consequences of $16 trillion of negative yielding debt globally are wreaking havoc on growth. In addition, the global central bank coordination which helped bring the global financial crisis to an end has been fractured courtesy of protectionism, the trade war and political pressure on central banks. This begs the question of whether easier monetary policy is sufficient to offset the ripple effects if global growth continues to weaken and/or the trade-related hit to U.S. corporate confidence.
Mixed economy tilting toward the downside?
Much of the recent volatility has likely been a symptom of investors trying to determine the extent of the U.S. economy’s weakness. The trade dispute with China has already hurt the manufacturing side of the economy, which is likely to be exacerbated by the multiplication of tensions. Manufacturing measures, such as the Institute for Supply Management’s (ISM) Manufacturing Index, and commodities that are indicators of economic growth, have both weakened of late.
The consumer side of the economy has held up well courtesy of still-healthy job and income growth, which has bolstered consumer confidence and spending. The only rub here is that high readings on consumer confidence have historically been leading indicators of recessions, with variability around timing; so any downturn in confidence would elevate recession risk. And although initial unemployment claims remain historically low, any sustained uptick—given their leading indicator status—would be troublesome.
For now, the weakness in the U.S. economy is largely concentrated in manufacturing, but further weakness could start to bleed through to services—which may be expedited if trade tensions and uncertainties worsen. We have already begun to see some slowing in the ISM Non-Manufacturing Index and its forward-looking New Orders component.
Pressure building on the Fed
With earnings season nearly over, Congress in recess through August, and a mixed economic picture, the focus is increasingly on the Federal Reserve. Pressure for further accommodative policy is rising as other central banks around the world have made dovish moves—pushing global interest rates even lower and putting upward pressure on the nearly $16 trillion of negative-yielding global debt (Deutsche Bank, CNBC). The spread between U.S. and global rates is drawing investors into dollar-denominated assets—especially Treasury securities, putting upward pressure on prices and downward pressure on yields. This has in turn pushed the dollar higher and made it more difficult for U.S. companies to compete internationally. Fed funds futures remain volatile, but another 25 basis points cut in September is fully priced in and the odds of subsequent cuts are rising. Yet, a race to the zero lower bound of rates may not be in the Fed’s best interest. We also aren’t sure the Fed will have the same impact it has had in the past. Lower rates likely won’t help in the resolution of a trade dispute or entice hesitant companies to increase capital spending. At this point, the Fed appears to be between a proverbial rock and a hard place. If they don’t meet investors’ expectations, markets will likely respond poorly; but if they continue to ease, investor concern over the condition of the economy may rise. Thus, it seems that a sustainable uptrend in stocks in the near-term is unlikely and volatility will continue.
Stock markets have become more volatile as trade tensions have worsened and weakness in the manufacturing side of the economy has caused increasing concern. Swift resolutions to these issues seem unlikely and a dovish Fed may not be the elixir to what ails the economy. With the likelihood of persistent volatility in the coming months, we recommend investors stay broadly diversified and focused on the long term. From a tactical perspective, we remain neutral to U.S. and global equities; with a bias within the U.S. market toward large cap stocks relative to small caps. Investors should not attempt to trade around short-term moves in the equity markets; but instead remain disciplined, diversified, and use rebalancing as necessary.
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 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 Institute for Supply Management (ISM) Manufacturing Index is an index based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders and supplier deliveries.
The Institute for Supply Management (ISM) Non-manufacturing Index is an index based on surveys of more than 400 non-manufacturing firms by the Institute of Supply Management. The ISM Non-manufacturing Index monitors employment, production inventories, new orders and supplier deliveries.
Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.
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