- Bottoming is a process. Market pullbacks, like what we experienced last week, are often difficult for investors to brush off, and can make sticking to their long-term plan challenging. It’s important to keep in mind that meaningful sell-offs are often followed by a period of meandering before markets regain their footing; often measured in months. It’s only been ~6 weeks since the initial spike in volatility in early February, and a comparison of the week ending February 9 and last week implies that the latter could be the necessary blow-off before stocks resume their fundamentally driven climb. Last week’s declines were characterized by lower trading volume and few lows across indexes (53% of S&P 500 Index stocks hit 20-day lows versus 80% in February), while the volatility index (VIX) reached roughly half the level it did at February’s peak. Also, put/call ratios rose to their highest levels in two years and equity exchange-traded funds saw $20 billion in outflows. Why are those things good? Because it suggests sentiment is starting to shift, and optimism must shift to pessimism before new lows can be established. Going forward, we’ll likely continue to see swings as markets look to go through the bottoming process, but our expectation remains that the S&P 500 will end the year in the 2950-3000 range as market fundamentals return to the forefront.
- Thoughts on equity positioning. Potential protectionist announcements may continue to weigh on investor sentiment, but when push comes to shove, we expect limited economic impact and manageable disruptions to corporate America. With economic and market fundamentals still solid, in our view, we are more likely to look for opportunities to buy dips rather than sell into this latest bout of weakness. In terms of positioning, we suggest suitable investors consider looking for opportunities to buy dips in small cap stocks, which have held up relatively well because their revenues tend to be more domestically focused and they benefit relatively more from tax reform due to higher effective tax rates. Also, we see trade-driven weakness in emerging markets and the industrials sector as a potential opportunity as well. We continue to favor value over growth as economic growth may accelerate, and the rally in the growth style appears stretched to us; while we expect value to get a boost from better financials sector performance.
- Perspective on trade risk. Last week, President Trump announced approximately $50 billion in tariffs on Chinese goods in response to China’s intellectual property thefts. China then retaliated with a smaller set of tariffs on U.S. imports valued at $3 billion, sparking fears of a wider trade conflict. We think it is important to put the size and scope of these actions into perspective. First, including the new tax law and the spending bill, up to $800 billion in stimulus (4% of U.S. gross domestic product [GDP]) has been put in place for 2018, according to Strategas Research Partners’ estimates. In contrast, the two sets of tariffs just announced a total less than $40 billion. Also note that the economic impact is likely to be marginal; Capital Economics estimates a 0.1% drag on China’s GDP as a result of these actions. In our view, the bottom line is the tariffs announced to date are just not big enough to derail the solid growth path of the U.S. economy. We explore in more detail in our latest post on the LPL Research blog.
- Some positive trade developments. On the trade front, several developments are worth noting: 1) there has been some progress in NAFTA talks, 2) additional exemptions for the recently announced steel and aluminum tariffs were granted, notably for the European Union, 3) the White House has a history of moderating initially hawkish stances, and 4) there is time for direct negotiations with China (which are already occurring), while comments from Chinese leaders suggest they are open to compromise. We are also somewhat encouraged by President Trump’s interest in the stock market and Larry Kudlow’s appointment as head of the National Economic Council.
- What to watch. The administration is expected to announce additional actions to protect U.S. intellectual property, including restrictions on cross-border investments and immigration, e.g., student visa. There is a comment/implementation period that allows time for negotiations with China, so tariffs could be watered down. Bottom line, there is ample time for lobbyists to be heard and changes to be made, though it is clear that this battle is not over and risk of additional policy-driven market volatility remains.
- This week we reveal our stock market Final Four. Kansas, Loyola, Michigan and Villanova are headed to San Antonio, Texas to determine this year’s NCAA Division I Men’s Basketball Tournament champion. In that spirit, following our Sweet 16 commentary from last week, in this week’s Weekly Market Commentary we will share our “Final Four Factors” for the stock market in 2018: 1) economic growth, 2) earnings, 3) trade policy, and 4) midterm elections. While we expect a hard-fought battle between these factors, and with it more market volatility, we still see solid gains for stocks this year and maintain our year-end fair value S&P 500 target range of 2950-3000. We recommend cyclical portfolio positioning, where appropriate, favoring financials, industrials, technology, small caps, and emerging markets.
- The latest Beige Book continues to suggest steady growth. The Federal Reserve released its latest Beige Book on March 7, ahead of its recent March 20-21 Federal Open Market Committee meeting. Our Beige Book Barometer (strong words minus weak words) rose to +68 in March, above the +62 reading in January, and in line with the +64 average for all of 2017. Taxes continued to be a hot topic, as did weather. Trade also saw a few mentions even though the Beige Book was compiled before the recent tariff announcements. Additional details will be available in our Weekly Economic Commentary, due out later today.
- Chicago Fed National Activity Index (Feb)
- Dallas Fed Manufacturing Index (Mar)
- Dudley (Dove)
- Mester (Hawk)
- Quarles (Dove)
- France: GDP (Q4)
- ECB: Weidmann
- Japan: PPI Services (Feb)
- Case-Shiller Home Price Index (Jan)
- Richmond Fed Manufacturing Index (Mar)
- Consumer Confidence (Mar)
- Bostic (Dove)
- Germany: Retail Sales (Feb)
- Eurozone: Consumer Confidence (Mar)
- Korea: GDP (Q4)
- BOJ: Outright Bond Purchase
- PBOC: Pan Gongshen
- MBA Mortgage Applications (Mar 23)
- GDP (Q4)
- Advance Goods Trade Balance (Feb)
- Wholesale Inventories (Feb)
- Retail Inventories (Feb)
- Pending Home Sales (Feb)
- Germany: Consumer Confidence (Apr)
- France: Consumer Confidence (Mar)
- Italy: Industrial Sales & Orders (Jan)
- UK: Consumer Confidence (Mar)
- UK: Lloyds Business Barometer (Mar)
- China BOP: Current Account Balance (Q4)
- Japan: Retail Sales (Feb)
- PCE (Feb)
- Core PCE (Feb)
- Personal Income & Spending (Feb)
- Weekly Jobless Claims (Mar 24)
- Chicago Purchasing Manager’s Index (Mar)
- U of Mich. Sentiment (Mar)
- Harker (Hawk)
- Germany: CPI (Mar)
- Germany: Unemployment Change (Mar)
- Italy: PPI (Feb)
- UK: Money Supply (Feb)
- UK: GDP (Q4)
- Turkey: GDP (Q4)
- Canada: GDP (Jan)
- Japan: CPI (Mar)
- Japan Industrial Production (Feb)
- Good Friday
- France: CPI & PPI (Feb)
- Italy: CPI (Mar)
- UK: Consumer Confidence (Mar)
- Japan: Housing Starts (Feb)
- China: Manufacturing & Non-Manufacturing PMI (Mar)
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. The economic forecasts set forth in this material may not develop as predicted.
The prices of small cap stocks are generally more volatile than large cap stocks.
Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.
Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time.
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