A view of the financial markets on Wall Street in New York.
2018 is off to a volatile start. We have already had triple the 1% days in the S&P than in all of 2017. The market has moved from one concern to another, the sell-off began in February on a concern of rising inflation and rates, it then moved to tariffs, and now to tech shares, writes Ketu Desai.
Tech shares sold-off late in the month behind concerns relating to Facebook, increased regulation, trade restrictions, and suspension of some driver-less car programs. This created a risk-off sentiment causing Treasuries to rally, which in turn hurt financials. When tech and financials fall, it is difficult for the market to perform well, as the sectors make up a combined 40% of the market. The risk-off sentiment benefited the 10YR and gold.
The market appears to be in a battle between the bears and the bulls, without a clear direction at the moment. The same piece of information is being viewed by each camp in favor of their market view. Take for instance, the Fed meeting this month. Bears would say the Fed is hawkish, quantitative tightening has begun, and will only accelerate in quarters to come.
Further, the Fed, despite the dot plot will likely raise four times this year and has pushed the Fed Funds rate to 3.4% in 2020, above their neutral rate of 2.9%. The pace of tightening might also invert the yield curve later this year or early next year, which is often a sign of pending recession. The spread between the ten-year and the two remains narrow. LIBOR has spiked in recent weeks, making funding more expensive and tightening financial conditions.
Bulls on the other hand would argue, while rates are rising, we are rising from a very low level. The neutral rate is extremely low compared to history, pre-crisis the Fed Funds rate was over 5%, and in the 1980s it was nearly 20%! Real rates are still negative to slightly positive. They would argue that inflation numbers that have come in this month continue to show that inflation is benign. Bears would argue the labor market is tight, and we got a hot wage number in January, oil prices have risen, we have fiscal stimulus, and it is only a matter of time before we have inflation.
They would also argue that the first quarter economic data globally, has been weak, Atlanta Fed GDPNow is less than 2.5% growth for Q1, we have had poor retail sales, European PMIs have been weak, China continues to limit credit. The counter would be first quarter growth for some reason has been weak for a number of years, only to bounce back in subsequent quarters. For instance, in 2016 and 2017, Q1 GDP was only 0.6% and 1.2%, only to bounce back to 2.8% and 3.1% in the third quarter, respectively.
Further, global growth will be around 4% this year. Perhaps, the strongest argument from the bulls is earnings are expected to grow nearly 20% this year with nearly 7% revenue growth, and earnings are an important determinant of equity prices. The impact of tax reform and deregulation is only beginning, and the size of these is quite significant. Valuation remains reasonable with the sell-off over the past couple of months, especially relative to other asset classes. Bears would counter that it has been a long bull market, and many other risks remain, ranging from the fiscal deficit, to mid-term elections, and a trade war.
The back and forth between bulls and bears, has led to a volatile market, as one camp takes control for a period, often intra-day. The market has been range-bound for a few weeks, with the bears taking control late in the month.
April will commence first quarter earnings, which could be important in breaking this back and forth.
Interested readers can reach Ketu Desai by email at firstname.lastname@example.org