Key Points

  • The modest downward pressure on stocks recently appears to be working off some overly optimistic sentiment. We view this as a healthy pause in an ongoing bull market.
  • U.S. political realities and the failure of healthcare reform contributed to the recent pullback in stocks but investors shouldn’t get discouraged. Economic data has hooked up—notably business confidence, which has led to a pickup in capital spending.
  • The official Brexit process has begun, and although a recession doesn’t appear imminent, risks have risen and volatility will likely rise.

Turning on the lights

After a party is over, and the host turns on the lights, the picture often looks quite different than it did just a few minutes before. The realities of the U.S. political process are being recognized and the "hard" economic data is not yet living up to the "soft" (confidence/survey-based) data. This has allowed some of the sentiment froth to ease, which we believe is a healthy development. The Ned Davis Research Crowd Sentiment Poll has pulled back from excessive optimism territory, while we finally broke a 109 day streak of no 1% decline days. A pattern of two-steps-forward, half-a-step-back is healthier than if the market had maintained its melt-up status in our view.

The recent pullback was mild, but under the surface, a larger correction occurred among individual securities; potentially setting the stage for the next move higher. According to Strategas Research Group, 24% of the S&P 500 has already experienced a correction of 10-20% from their 52-week highs, while another 14% are down more than 20%.

We have recently opined that some of the optimism about the administration's pro-growth policies may have accelerated too sharply. The failure of the Affordable Care Act (ACA) reform attempt shown light on the process that is lawmaking in the United States, and it often isn’t pretty. But investors appear heartened by the renewed focus on tax and regulatory reform.

"Soft" vs "Hard"

Investors are facing the realization that "soft" data—such as confidence readings and business surveys—doesn't necessarily translate immediately into "hard" data—like retail sales, capital expenditures, and industrial production. It's this hard data that translates into economic growth and increasing profitability. Looking at some of the parabolic moves in recent confidence surveys, it would be difficult for hard data to keep up.

Tough acts to follow

Tough acts to follow

Source: FactSet, Conference Board. As of Mar. 28, 2017.

NFIB Small Business Optimism Index

Source: FactSet, Natl. Federation of Independent Business. As of Mar. 27, 2017.

Historically, wide spreads between soft and hard data tend to narrow in both directions—soft data tends to retreat, but hard data tends to play some catchup. We expect that pattern in this cycle, too. (read more on Hard vs. Soft and the implications from Liz Ann Sonders here.

There do exist some impediments to higher growth. Within housing, existing home sales fell 3.7% in February, with the National Association of Realtors noting that "buying interest is strong" but "we don't have enough inventory to satisfy that buying interest." That dip contrasts with the 6.1% rise in new home sales, and a strong reading in confidence from the National Association of Homebuilders.

Additionally, the flat industrial production reading from the Federal Reserve was a bit disappointing, but it was largely influenced by a 5.7% drop in utilities output due to warmer-than-average weather in much of the United States. Finally, the Index of Leading Economic Indicators (LEI) moved higher, as have miles driven by U.S. drivers, and railcar loadings—all signs of economic growth. In fact, for the first time in this recovery/expansion, the LEI finally took out its prior pre-recession high—a sign that recession risk remains quite low.

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