Keeping Recent Stock Movements in Perspective
- The suddenness of the recent current sell-off in global stocks has surprised us given the solid underpinnings of robust corporate performance and synchronized global economic growth.
- We believe markets were complacent and a return to more normalized volatility levels will ultimately favor stock picking.
- Signs of an improving economy, such as accelerating wage growth in the U.S., should provide a tailwind for companies, especially as key inflation data remains below the Federal Reserve’s target.
Global stocks slipped again on Monday and early Tuesday, extending a bout of weakness that has roiled markets after significant advances were accrued in January. In the U.S., the S&P 500® Index has declined over 10% since achieving a record high last month. We highlight this high-water mark as only two weeks ago stocks seemingly had the wind at their back. We still believe that.
We have been concerned about market complacency, as indicated by subdued volatility, over much of the past year. Still, the ferocity of the current sell-off did surprise us, especially as we believe the environment that drove stocks to recent highs remains largely intact. While this particular spike in volatility is pronounced, higher levels of volatility than what the market has recently experienced, in our view, tend to provide opportunities for the research-driven stock selection available in active management.
A Push Higher – Then Higher Still
Last year’s rally hit an inflection point in August as the prospect of tax reform in the U.S. grew. Rather than taking a pause once the legislation was passed, equities found another gear, climbing as much as 7.4% in January, as measured by the S&P 500® Index. January’s total gain was the highest of any month since March 2016, thus, the market was potentially ripe for a pullback. We should note, however, that the sell-off has only taken stocks down to mid-December levels, a period marked by investor enthusiasm for the tax package and synchronized global growth.
Supported by Solid Fundamentals
December was also a period in which we were constructive on U.S. stock valuations. We believed at that time – as we do now – that multiples are justified, given sound corporate performance and a growing economy. Rather than basing our optimism for further stock gains on multiple expansion, we expect consensus-beating earnings growth to be the primary catalyst going forward.
A manageable rise in volatility should provide our analysts the opportunity to identify stocks we favor that may be trading at material discounts to what they were only a few weeks ago. And there are plenty of candidates, with roughly half of S&P 500® Index components reporting, both sales and earnings growth have exceeded analysts’ expectations, with the former rising just shy of 10% year over year and the latter by roughly 15%.
In It for the Long Term
Our outlook for future earnings growth remains favorable. Our analysts have dissected the recent batch of earnings statements and are reassured by results, which have been within, or ahead of, our expectations. As important, we work hard to identify investment trends that will play out over years, not days, weeks or quarters. Just because stocks stumbled, it does not mean that biotechnology companies won’t continue to develop innovative therapies to improve patient outcomes. It does not mean that millions of Chinese consumers will stop aspiring to enter the middle class and buy a range of health and lifestyle products barely imaginable to the previous generation. Nor will a market hiccup slow the global migration from cash to credit cards and digital payment platforms.
And About the Market Environment
There is already plenty of conjecture about the source of recent market volatility. One candidate is improving economic conditions in the U.S. and their potential impact on inflation and monetary policy. Wages, for example, rose by 2.9% year over year in January, the highest rate since 2009. It bears repeating that some inflation is a sign of a healthy economy and that companies can more easily raise prices in such an environment; that is bullish for equities. Also, a key goal of nine years of accommodative monetary policy was to boost inflation toward the Federal Reserve’s (Fed) 2% target. The U.S. economy is still shy of that objective as year-over-year headline and core inflation – as measured by the Fed’s favored gauge – stand at 1.7% and 1.5%, respectively. As for concerns that the market has underestimated the willingness of the Fed to raise interest rates this year, the futures market currently pencils in two hikes in 2018, just shy of the 2.5 increases based on a survey of Fed members.