Political Volatility Still Driving Financial Markets; Can 1Q Earnings Ride to the Rescue – Week Ended 4/13/18

Choppy market action that persisted throughout February and March is continuing this month against an increasingly unpredictable political backdrop. 2Q began with a horrible first day and stressed week, but the slide was reversed last week despite no shortage of fresh unsettling headlines. For the week ending Friday the 13th, the S&P added +2%; some of the momentum areas hardest hit in recent weeks (Amazon, Tesla, Facebook) also managed to enjoy some of the best relative performance as the negative news flow for them eased a touch. Interesting though amid the choppier weeks is that smaller-size companies have actually fared better than their larger-cap brethren. Of additional merit, credit spreads (often a leading indicator of problems below the surface) tightened last week, suggesting that while US equities remain in closer proximity to the lows of the correction range than the upper, the underlying economic and corporate fundamentals are still perceived as OK. In that regard, the correction is appearing to maturing, and maybe nearing a tradeable conclusion.

Interestingly, while the economy and corporate earnings still appear to be sound if not outright accelerating, some data is becoming more noisy, particularly overseas. Measures of industrial production and investor sentiment are dropping across developed Europe. US consumer sentiment was also reported to have slipped in recent weeks on rising trade fears. The monthly employment report in the US was also less robust than anticipated and those of recent memory. Soft measures of sentiment and activity such as company surveys, have also given up a little ground, at the same time as inflation data continues to suggest price levels are rising. It is true that the stock market can create its own self-fulfilling problems if a particular mood or uncertainty persists for long enough. But we also suspect the hostile political environment which includes tariff threats between major economic powers; a Russia-collusion investigation that looks to be spilling over into seemingly unrelated past personal-transgression areas for the President, and announced resignation of House speaker Ryan at the end of his current term. Add the renewed conflict between Syria, Russia and the rest of the world, and it is not hard to see why confidence might deteriorate. In fact, will it be the sorry political state of our country that is most squarely to blame whenever the current economic cycle comes to an official end?

As we enter the second-half of April, some of the most important fundamental inputs to longer-term financial market performance looks set to reinforce the most positive trends of the last 18 months. Specifically, corporate earnings season gets fully underway this week, and it is widely anticipated index earnings will be up by mid-teens over the same period a year-ago. That is exciting progress, and should allay the most acute concerns that stock prices rose too far too fast. But from an investors perspective, it is also important to try and understand what is already priced into the market. Are expectations so rosy that the bar for positive surprise is too high? Will investors fail to be impressed if companies only deliver +15-18% growth (a huge change in historical context!)? This fits with the idea that 2018 and 2019 might well be years in which the economy outperforms the market. Of additional consideration, but more challenging to invest upon, is that 2018 is another mid-term election year. At this point and with stubbornly low approval ratings, it seems likely that another major shift in the composition of Congress might be in store (Republican party loses its narrow majority). If that transpires, and the special investigation into Trump continues to cross into unexpected and seemingly unrelated areas, it is not inconceivable that talk of impeachment will further build. Markets would not like the uncertainty that such a sideshow would create in the short-run; or how much of recent actions taken might be reversed. In that vein, we suspect the elevated level of volatility presently being witnessed relative to what was enjoyed throughout 2017 is likely to persist. Long-term investors would be wise to try and condition themselves to being comfortable with feeling uncomfortable.

Posted in Blog Post.