3 July 2018
The U.S. Stocks are searching for balance
U.S. stock market indexes have been able to keep moving, remaining near the top of the recent range despite rising trade concerns. There appears to be at least a temporary balance between positive developments and the proverbial “wall of worry.” A more hawkish stance by major global central banks and escalating trade disputes have been offset by still-high business and consumer confidence and accelerating economic growth. Investor sentiment, according to the Ned Davis Research Crowd Sentiment Poll, has been relatively neutral, edging higher but not in excessive optimism territory (remember, sentiment is a contrarian indicator at extremes). U.S. Treasury yields have rebounded from the Italian political crisis-related drop, but haven’t been able to again breech the 3% level; oil has pulled back slightly; and geopolitical concerns have come off the boil. We don’t believe this “balance” will last forever, of course, but the bicycle could keep moving along in the near-term.
Commentators and pundits have been talking about “peaks” quite often — peak earnings growth, peak economic growth, peak fiscal stimulus, peak monetary stimulus, etc. It may be that this slower-than-average recovery/expansion allows those peaks to be put off further than expected, allowing the bull market to persist. If there is an advantage to this having been the weakest expansion in U.S. history it’s that even with it being the second-longest in history, its weakness means many of the excesses that tend to build and cause recessions aren’t yet present.
The trespasser strikes again
We won’t mention the young lady by name, but the girl who broke into a house and ate the food and slept in the bed may be back again—helping to support the ongoing bull market. As the first half of the year draws to a close, the Atlanta Fed GDPNow forecast for second quarter growth—which traditionally trends lower throughout the quarter as new data comes in—has been trending higher and now stands at a robust 4.7%—still likely a bit higher than what we’ll actually see, but encouraging nonetheless. The recent retail sales report released by the Census Bureau supports that better growth, as overall retail sales rose 0.8% month-over-month (m/m), while ex-autos and gas, sales were also up 0.8%—much better than expected.
Trade war or minor skirmish?
Tariffs and ongoing trade disputes are likely to add to near-term volatility but we also believe that there is an asymmetric risk assessment in this situation. The consensus is that trade wars are bad, and we don’t disagree. But we are not yet fully down that slippery slope and there remains the possibility of a constructive ultimate outcome benefitting both the United States and its trading partners. President Trump noted that he suggested to his fellow G-7 members that they should get rid of all tariffs and trade impediments. That’s not going to happen, but a best-case scenario is that we end up with freer trade than when we started. A worst-case scenario is that the rhetoric and tariffs proposals continue to ramp, we head into a true trade war, and that it results in deteriorating confidence, weaker economic growth and higher inflation. That would result in the “trade wars are bad” mantra becoming a self-fulfilling prophecy.
Don’t Worry, Be Happy — Bobby McFerrin…and Jerome Powell?
The trade worries apparently didn’t extend to the Federal Reserve, as they again raised rates and expressed few concerns that the disputes would impact U.S. growth in a meaningful way. In his initial press conference—which he must have loved, as he signed up to do one after every meeting beginning next year—he painted a downright rosy picture. The Federal Open Market Committee (FOMC) upped its forecast for rate hikes in 2018 to a total of four from three. Chairman Powell, the first non-economist to head the Fed, used a more plain speaking approach and waxed optimistic, calling economic growth “solid.” He indicated that gradual normalization will continue, but at this point the Fed sees no reason to move into restrictive territory. Indeed, inflation has ticked higher, but still remains at relatively modest levels, while despite the historically low unemployment rate, wage increases remain modest.
Despite a recent modest pullback in U.S. stocks, and a sharper one in international markets—reflecting both trade worries and the recent strength in the U.S. dollar—we don’t believe it marks the beginning of a more severe correction. Risks of a prolonged trade dispute have risen but it’s too soon to declare war; while the possibility of a positive resolution that would likely be a tailwind for equities. For now, a healthy U.S. economy is an offset to those growing worries. Threats to the current bull market have risen, and they include this being a midterm election year—which have historically been accompanied by larger-than-average maximum drawdowns. We continue to espouse discipline and diversification; but for now it’s in the context of an ongoing bull market.
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 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