12 March 2018
U.S. Market is Getting Back to…Normal?
U.S. stocks have been on a wild ride recently—a stark contrast to the relative calm that dominated most of the last year. Stock indexes touched correction territory (+10% loss) in early February before staging a sharp rebound, with intraday several hundred point Dow moves more common than not. Recently the rebound began a retracement as investors expressed concerns about the potential for a more aggressive Federal Reserve and the initiation of more direct protectionist trade policies by the Trump Administration, including a 25% tariff on steel and a 10% one on aluminum. Stomach churning at times but should we be surprised? After a decade of abnormally loose financial conditions and global central banks massively boosting their balance sheets and taking rates to zero or below, we have begun the normalization process. Even in less unprecedented times, tighter monetary policy has led to higher volatility and weaker markets; so fundamentally, this is not a surprise.
Positively, despite the sharpness of the correction, investor confidence in the financial system appears intact with the rebound seen in the immediate aftermath of the February correction. There was some concern that the carnage among the inverse volatility-related exchange-traded notes could spread to create more systemic issues; but that does not appear to be the case. But the stock market has been less forgiving about the announcement by President Trump of new tariffs on steel and aluminum, which lacked any details. The concern that this could lead to trade wars and retaliatory measures by other countries, and ultimately hurt economic growth and foster higher inflation, was enough to send shivers down the stock market’s spine. In the meantime, the strong earnings picture is intact for now, which should help to underpin stocks. According to FactSet data, the “beat rate” for profits was 74% for the fourth quarter of 2017—above the 69% average over the past five years; while the revenue beat rate was 78%—a record high since FactSet began tracking the data in 2008.
A longer-term perspective
We believe increased volatility will persist, with alternating bouts of spikes, followed by periods of easing conditions. Concerns over economic growth moving to a higher trajectory and inflation heating up will likely continue to be a factor, with worries that the Fed may be forced to tighten more quickly an ongoing volatility-driver. The current Fed Chair Jerome Powell had the “pleasure” of talking to Congress for two days; and despite his clear intention to say little that would immediately move markets, investors took his first day of testimony as slightly hawkish, resulting in some selling of stocks. But Powell adeptly came across as slightly more dovish in day two and stocks were rallying…until the Trump tariff announcement.
Interest rates have risen, both on the short- and long-end, but they remain low in the longer context of history. Although the yield curve has flattened, until an actual inversion (were it to occur), and even though past performance does not indicate future results, stocks have shown a tendency historically to perform well during the flattening phase—with volatility hiccups.
It’s a mixed picture as earnings are getting better at a rapid clip. According to Thompson-Reuters consensus estimate data, expectations for 2018’s year-over-year growth for the S&P 500 have jumped from 11% last fall to nearly 20% today. The trend in, and forecasts for, gross domestic product (GDP) have been less robust, with fourth quarter GDP being revised down slightly. Looking ahead the Atlanta Fed’s GDPNow model estimates 3.5% annualized growth for this year’s first quarter. Inflation has ticked up, with the overall Consumer Price Index posting a 2.1% annualized growth rate in January—1.8% at the core (excluding food and energy) level. More recently, we saw a further uptick in the core personal consumption expenditures (PCE) price index to 1.5%, up from 1.3%. Core PCE is considered the Fed’s “preferred” measure of inflation, and it remains below their 2% target. However, noticed by markets was that the index is up at a 2.0% annual rate over the past six months.
We believe that there are still supports to an ongoing bull market, but with the Fed continuing to remove monetary accommodation by more quickly raising interest rates and letting assets roll off their balance sheet, increased volatility seems likely to continue. For now, the core of the American economy looks good—with consumers remaining confident and the labor market healthy—and corporate earnings growth has surged. But the ongoing implications for the economy and earnings of higher inflation, tighter monetary policy and more overt protectionism from the Trump Administration have not yet fully played out. Burgeoning deficits and debt are also concerns for the growth rate trajectory of the economy, household debt levels are less cumbersome courtesy of the deleveraging undertaken in the aftermath of the financial crisis.
Monetary policy “normalization” could continue to be a bumpy one for U.S. and global equity markets, even if it’s in the context of an ongoing secular bull markets. Earnings and economic growth remain healthy globally, but the expectations bar has also been set higher; and we have yet to witness the implications on the global economy, earnings and/or investor sentiment of the heightened level of protectionism.
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
The Consumer Price Index (CPI) is an index that measures the weighted average of prices of a basket of consumer goods and services, weighted according to their importance.
The core PCE Price Index is personal consumption expenditures (PCE) prices excluding food and energy prices. The core PCE price index measures the prices paid by consumers for goods and services without the volatility caused by movements in food and energy prices to reveal underlying inflation trends.
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