8 April 2019
U.S. Stocks Resumed Uptrend but Risk of a Pullback Appears Elevated
U.S. stocks have continued their sporadic move higher, after a short-lived dip associated with the inversion of the yield curve; recovering much of their fourth quarter 2018 losses. We never scoff at rising equity prices, but we are becoming increasingly concerned that gains have exceeded the fundamental underpinnings, at least near-term.
Uptrend intact—but too far too fast?
Positive macro supports have been evident, including hopes for a trade deal with China and the 180 degree turn toward dovishness by key central banks, including the Federal Reserve and the European Central Bank (ECB). There are also some temporary factors which put downward pressure on first quarter growth, including severe weather and the government shutdown. That said we are concerned that those positive vibes may be obscuring some potentially negative developments; not least being the message the bond market and yield curve has been sending.
In keeping with rally, investor sentiment, according to the Ned Davis Research Crowd Sentiment Poll, is back in extreme optimism territory, while valuations have moved back into elevated territory. The forward P/E for the S&P 500 is now 16.3, above the 15-year average of 14.9 (Strategas Research). This has been driven by both stocks moving higher and earnings estimates moving lower. As mentioned, Refinitiv shows the consensus for first quarter S&P 500 earnings to be -1.8%, with only slightly positive expectations for the subsequent two quarters. And while financial conditions have eased, contributing to multiple expansion so far this year; earnings may have to start doing more of the market’s heavy lifting—a not insignificant task given myriad headwinds facing earnings growth.
Real story may be somewhere in between
For those who lived through the Polar Vortex, spring is likely a welcome reprieve. Add in the government shutdown, and it made for a rough first quarter The Atlanta Fed’s GDPNow estimate has moved up to a still-weak 1.5% annualized growth, up from just 0.2% just a few weeks ago; and the government is still trying to catch up from the shutdown with respect to some economic data. As mentioned, some temporary factors appear to be fading, which could lead to a lift in the second quarter. Even the Fed acknowledged at the March FOMC meeting that “economic activity has slowed from its solid rate in the fourth quarter.” How much of a rebound we’ll get is in question; but we continue to believe trade holds the key. According to myriad reports, including from The Wall Street Journal, trade talks with China remain bogged down; although there were recently high- level talks again scheduled. Adding fuel to the concerns was President Trump’s recent proclamation the tariffs will remain in place for a “substantial period.” The outcome is impossible to know at this point, but it does keep business confidence under pressure and will likely result in ongoing delays to investments in capital and equipment.
Fed doubling down on dovishness
Many investors have pointed to the Fed as a reason to get more bullish on stocks. We concede its turn toward dovishness and putting rate hikes on hold have been positive market supports. The Fed’s so-called “dots plot” of economic and rate forecasts from its most recent meeting now show no rate hikes in 2019. Investors on the other hand, as per the fed funds futures market, believe the next move (this year) will be a rate cut. We lean more toward a cut than a hike, but we are concerned that investors may become complacent to the binary risks of a sharper slowdown in growth, or a flare up of inflation due to the tight labor market. We continue to believe any inflation flare up would be fairly benign, but with wage growth having picked up sharply (average hourly earnings are up 3.4% y/y as of February), and the rampant skills shortage, we don’t think an inflation scare should be taken off the table.
Could the worst already be over internationally?
The weakening global economy is being highlighted by the inversion of the U.S. yield curve, with long-term bond yields continuing to fall. Over the past 50 years, U.S. yield curve inversions came about one year before each global recession. Being prepared for volatile markets has been a key message as we pointed to the yield curve’s march toward inversion over the past few years. But now that it has inverted, what should you do? If you have prepared your portfolio, reevaluated your investment plan, confirmed your risk tolerance, and rebalanced your assets, there may be little you need to do. Remember, staying disciplined allows investors to ride out market downturns better than those investors who throw discipline to the wind. Of course, there is no way to be sure and both U.S. and international stocks could resume the declines seen last year. Either way, the message for investors is the same: remain prepared for volatile markets.
Brief dips in U.S. stocks have done little to dent investor confidence; and with an inverted yield curve, trade uncertainty continuing, economic growth slowing and earnings possibly declining in the first quarter, we believe a pullback is becoming increasingly likely. Investors should remain disciplined and diversified and continue to prepare for the inevitable end of this cycle—without needing to pinpoint the timing precisely.
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 Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.
The S&P 500 Composite Index is a market capitalization-weighted index of 500 of the most widely-held U.S. companies in the industrial, transportation, utility, and financial sectors.
Ned Davis Research (NDR) Sentiment Poll shows perspective on a composite sentiment indicator designed to highlight short- to intermediate-term swings in investor psychology.
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