Key Points

  • U.S. equities turned around 180 degrees on a reduction in investor fear that had been building. We believe this is a positive shift, but underlying fundamentals haven't changed.
  • Recent soft economic data contributed to the earlier stock market slump, but economic growth continues to muddle through, and a recession doesn't appear imminent. The earnings bar was set high as reporting season began, but companies have largely beaten expectations.
  • Putting too much emphasis on political risk globally could be one of the bigger risks facing investors in the current environment.

Stocks make abrupt u-turn

Recent market action has all the markings of a relief rally. The French vote in favor of centrist candidate Macron took "Frexit" off the table for now; a new tax cut proposal by the Trump administration, and the decreasing likelihood of a near-term U.S. government shutdown all appeared to play a part in the sharp rise in stocks and plunge in volatility.

Stocks rose sharply

Stocks rose sharply

Source: FactSet, Standard & Poor's. As of Apr. 25, 2017.

While volatility fell

While volatility fell

Source: FactSet, Chicago Board Options Exchange. As of Apr. 25, 2017.

There was a sharp reversal within the stock market as well during the pullback—or "risk off" phase. Defensive sectors, such as utilities and consumer staples benefitted from skittishness about the economy; while some more cyclical sectors, such as energy and financials had a rough go. In keeping with those moves, Treasury yields moved lower, illustrating a rising level of concern among investors. Notwithstanding geopolitical uncertainty and concerns about fiscal stimulus, our faith in the sustainability of the economic expansion was not tested, as leading indicators continue to point up. Instead, the consolidation period for U.S. stocks helped relieve some of the overbought conditions which had developed; which in turn helped alleviate overly optimistic sentiment. The Ned Davis Research Crowd Sentiment Poll moved back toward neutral territory and helped build a good base for the next move higher.

Those risk-off trades have suddenly staged a sharp reversal, with more cyclical areas of the market benefitting; while Treasury yields have moved higher, indicating a sudden appetite for increased risk. The change in market behavior is welcome, but it could swiftly bring back excess investor enthusiasm—often a contrarian indicator. In addition, U.S. growth experienced yet another soft patch in the first quarter; from which it needs to emerge to enable the bull market to continue.