Resurgent volatility hit global markets again last week. The recent market drawdown was not isolated to the U.S. The chart below shows the performance of major global markets from the recent record highs on Jan. 26th through March 5th (in red). It also shows performance from the January peak to the Feb. 8th trough (orange) with most markets correcting around 10 percent. Most markets have recovered a significant share of those losses with the United Kingdom and the Eurozone the lone laggards due to concerns surrounding Brexit negotiations and last weekend’s Italian elections. Small cap U.S. stocks held up relatively well during the drawdown.
Global stock markets had patiently waited for a correction of 5 percent-10 percent throughout 2017 while the lowest volatility on record persisted. Jan. 26th marked record high prices in many global stock markets but rising wages in the Feb. 2nd employment report caused markets to fall sharply in fear that Fed policies would become more aggressive. With the recent correction now on the books, global markets have shifted and are now on alert as they are highly sensitive to future sources of risk. Some new catalysts behind last week’s renewed volatility include:
- Trade policy friction
- European elections
- Fed Chairman Powell’s testimony
Bottom Line: Directionally, U.S. stock markets continue to lead other global stock markets. Continued strong economic growth provides a supportive backdrop for global earnings and, therefore, equities. The low volatility regime that persisted since the fall of 2016 has ended and is expected to re-establish a new elevated low-end to its range.
Trade Policy Friction:
Markets declined 2.5 percent last week on news of President Trump’s proposed tariffs for international suppliers of steel (25-percent tariff) and aluminum (10-percent tariff). Details should evolve later this week with the possibility this announcement was intended as leverage related to the ongoing NAFTA negotiations. These tariffs are primarily relevant due to possible retaliation among world trading partners. Markets reacted negatively because tariffs (if implemented as proposed) could lead to rising inflation causing markets to fear an overly aggressive Fed response. At this writing, markets have already recovered much of the initial drawdown related to last week’s tariff announcement. We will watch closely as this story develops throughout the week for signs of discord within the GOP and any corresponding shift in position from the White House. We think risks of a full-scale trade war are low.
March 4th saw elections in Italy and the formation of a grand coalition in Germany to pave the way for Chancellor Angela Merkel’s fourth term. European markets had struggled to regain much of the losses seen since Jan. 26th with fears about poor election outcomes.
Italy: With no clear victor in Sunday’s elections, Italian political leadership is unresolved which, for now, is a market neutral. With no party winning a clear mandate, it could take months to gain clarity on either political leadership much less the market reaction to such an outcome.
Germany: Angela Merkel’s fourth term is viewed as a market positive even though her party lost several seats. In short, a stable Germany is essential to stability in the entire Euro region.
Bottom Line: Most European markets remain below their 200-day moving average and are valued at levels dating back to last summer. Markets continue to largely reflect risks to the Eurozone but stand to gain support over the next two or three months as the dust settles.
Fed Chairman Powell’s Testimony:
The first downdraft in U.S. stock prices last week was due to comments made by new Fed Chairman Jay Powell. It is typical for markets to experience large drawdowns in the first year of a new Fed chair as they adapt to new leadership. Powell expressed he has seen an improving economic outlook since December. Markets immediately sold off thinking his testimony could signal an accelerated pace of future rate hikes. Market expectations have risen for four rate hikes in 2018, our base case since 2017. The first Fed meeting under Powell is March 20-21, when the Fed is expected to offer modestly higher rate guidance through 2018 supported by continued economic strength and firming inflation trends. Aggressive Fed policy is thought by many to be the death of a bull market and, for that reason, will remain front and center.
Above, we’ve provided examples of three data sets markets leaned on to lead U.S. stocks down by roughly 4 percent last week. Markets are becoming increasingly sensitive and are sifting through changing data looking for the next correction catalyst. This is not a market negative but rather a market reality that can be expected in the late stages of a bull market. Some of the most attractive returns can be earned in the latter stages of a bull market so stay invested.
Key takeaways for the coming weeks:
- Global economic growth continues to support robust earnings growth with no signs of recession
- Earnings growth will grow faster than share prices in 2018
- Fiscal stimulus is a long-term debt concern but a short-term economic stimulus
- Quarterly rate hikes are likely but not fully priced in
- Markets will look to the March 9th employment report as the next near-term test
- Trade wars are unlikely, and we expect to see a tug-of-war between rhetoric and reality
- Fears of spiraling inflation and interest rates are overblown but will remain an economic lightning rod
- A healthy business cycle has taken control from the Fed’s “new normal” regime
- We remain in a bull market with stocks expected to outperform bonds
- Stay invested but volatility is here to stay
This piece is produced by BB&T’s Wealth Portfolio Management Team.
The information set forth herein was obtained from sources, which we believe reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation by us of the purchase or sale of any securities. Diversifying investments does not ensure against market loss and asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. Past performance does not guarantee future results.