29 Aug 2016
The US Market Calm Unlikely to Last—Be Prepared
Volatility has fallen to near multi-year lows amid the traditionally slow summer vacation season. Congress is out of session, and much of Europe is on vacation as well. But traders will come back to work, politicians and central bankers will return to problems which haven’t gone away, and market action and volume should both ramp up.
We remain neutral on U.S. equities, which means we recommend investors remain at their long-term target equity allocations, while using volatility to tactically rebalance around those levels. We believe the current bull market will continue but not without some additional drama. The nice thing about the past month is that it has allowed investors and policy makers alike to catch their breath following the chaos that followed the Brexit vote. The sharp selloff was followed by a steep rebound and move to new record highs for major indices. Investor sentiment had moved into excessive optimism territory, according to the Ned Davis Daily Trading Sentiment Composite, but it’s since pulled back toward neutral territory. And longer term sentiment remains relatively pessimistic, despite the move to new record highs. Investors pulled another $6 billion out of U.S. equity mutual funds and exchange-traded funds (ETFs) in the week of 8 August, bringing the year-to-date total to $95 billion, according to ISI Evercore Research—close to record outflows. This continued doubt among investors makes us feel more comfortable with our mildly bullish view—remember, investor sentiment tends to work in a contrarian fashion.
Steady improvement in economy
The latest batch of U.S. economic data doesn’t appear to presage an imminent recession, which would typically lead to a bear market. Consumer confidence has firmed, with the labor market continuing to improve, housing looking good, and wages finally starting to rise. Additionally, we’ve seen both revolving consumer credit and bank loans increase, indicating consumers may be more comfortable taking on debt.
Productivity continues to decline
It will be difficult to get the U.S. economy rolling without an improvement in productivity. A contributing factor to weak productivity is undoubtedly ongoing tepid capital spending. The National Federation of Independent Business (NFIB) recently reported that small business optimism ticked only slightly higher to a still relatively lackluster level of 94.6. For context, from 2000-2006, this reading spent much of its time at or above the 100 mark. Additionally, industrial production has been relatively weak, but there is some hope as gains have been posted in the past two months.
Policy makers at a loss?
Both monetary and fiscal policy makers appear at a loss as to how to grease the economy’s gears. Employment remains strong, and wages have been rising, but spending on productivity- and efficiency-enhancing equipment remains quite weak. We also believe that low, and even negative interest rate policies globally, may be having the opposite of the intended affect. The Wall Street Journal recently showed that consumer savings rates in countries with negative interest rates have actually risen. We could be seeing the same thing among U.S. businesses, with low interest rates being used to pay off debt, buy back shares, or bolster cash reserves… but not invest in broader growth producing initiatives.
The summer lull shouldn’t allow complacency to set in. We expect the U.S. bull market to continue, but risks remain and volatility is likely to pick up. But with a solid U.S. consumer, and modestly improving economic and earnings growth, we think the general equity trend will be higher.
This material is issued by Charles Schwab, Hong Kong, Ltd. The information provided here is for general informational purposes only and has not been reviewed by the Securities and Futures Commission in Hong Kong.