Key Points

  • Investors appear to be shying away from risk, resulting in a pullback in stocks. We view this as temporary, although patience will be required and sharper downturns could occur within the ongoing bull market.
  • "Hard" economic data hasn’t accelerated to the same degree as "soft" data (confidence/survey-based), and some convergence is expected. Political and geopolitical uncertainty abounds, while the Fed has begun to address the slow draining of its balance sheet.
  • Global earnings have aided stock market gains, but the expectations bar is getting higher to hurdle. The next several weeks should show whether gains will persist or if expectations may have gone too far.

Risk and reflation rerating

Investors appear to be taking another look at the risks they are willing to take, while also considering whether the reflation story may not develop as hoped. Reflation is the process of getting economic growth and price broadly back to pre-recession levels. While progress has been made, growth is still not accelerating. First quarter real gross domestic product (GDP) is forecasted to come in around a 1% annualized level according to Bloomberg. Add in disappointment with the political developments—the hoped for stimulus coming from Washington is at least delayed; the Federal Reserve is talking about reducing its balance sheet; and geopolitical tensions are rising—and you have a good mix for investors to pare back some risk. Stocks have trended modestly downward, while more cyclical areas of the stock market have struggled at the expense of more defensive areas. We've also seen yields reverse course after surging on hoped for fiscal stimulus and rising economic growth.

Yield reversal indicates paring back of risk

Yield reversal indicates paring back of risk

Source: FactSet, Federal Reserve. As of Apr. 10, 2017.

We don't see this as the beginning of the end of the bull market, however. Economic growth is still positive, and business and consumer confidence surveys continue to be quite strong. Additionally, as we head into the heart of earnings season, expectations are for a strong season, with FactSet reporting that analysts are expecting first quarter S&P 500 earnings to rise 9.1% over a year ago, which would be the highest growth since 2011. A risk, however, is that the bar has been set too high, which could make it harder to achieve upside surprises. But solid earnings and economic growth should enable the long running bull market to continue. Investors will likely have to don their patience and discipline caps, as there could be further pullbacks. Geopolitical tensions are also threatening to shake the market, with North Korea testing weapons and Syria’s atrocities; with the U.S. response to both gaining worldwide attention. The world doesn't yet have a good idea how the current administration, or other global leaders, will handle these tensions, so bouts of volatility should be expected. In fact, for the first time in over 100 days, the CBOE Volatility Index (VIX) moved above its 200-day moving average.

Economic picture mixed but still positive

Frustration with the lack of meaningful acceleration in the "hard" data persists although the labor market continues to look solid—notwithstanding the modestly weaker-than-expected March labor report, which likely had weather as a culprit. After ticking slightly higher, jobless claims again fell last week and remain historically low; while the ADP employment report showed a surprising 263,000 private sector jobs were added. As noted, the jobs report from Department of Labor was disappointing with only 98,000 jobs being added, however the unemployment rate fell to 4.5%, the lowest level since 2007. We have highlighted that we expect job gains to moderate as the unemployment rate falls, due largely to there being fewer qualified workers available for hire. However, corporate and consumer caution persists, despite elevated sentiment readings, likely due to policy uncertainty in the aftermath of the failure of healthcare reform. As seen below, the Conference Board’s measure of consumer confidence remains elevated, while both Institute for Supply Management's indexes (manufacturing and services) remain firmly in territory depicting expansion.

Consumer confidence remains elevated

Consumer confidence remains elevated

Source: FactSet, Conference Board. As of Apr. 10, 2017.