Highlights
• We believe the worst of the correction may be over, but also think we could see additional sharp swings in the weeks to come.
• Fundamentals remain strong for the economy and for equity markets.
• We think equities will see gains for all of 2018, but investing conditions are growing more complicated.
The initial market pressure that began two Fridays ago intensified last week, driving stock prices sharply lower amid intensely rising volatility. What started as concerns about overvaluation, emerging inflation threats and rising bond yields spiraled into a near-panic selloff as technical and structural market conditions exacerbated the slide. The Dow Jones Industrial Average experienced two separate 1,000 point declines last week, the S&P 500 500 Index lost 5.1 percent for the week and has now declined 12 percent from peak to trough.1 While we think the worst of the correction may be behind us, messy market conditions may continue. And the long-term outlook is growing more complicated.
Weekly Top Themes
1. The recent spikes in volatility have been due in part to technical market factors. As markets started to fall, bid/ask spreads widened and highly leveraged low-volatility strategies were forced to unwind.1 In our view, this accelerated selling and contributed to the panic-like conditions early in the week.
2. Rising inflation pressures could act as an ongoing headwind for stocks. Improving wage growth was one catalyst that sparked the current correction. We expect this trend will continue putting upward pressure on inflation and bond yields. A combination of tax cuts and significant federal spending increases may accelerate these developments.
3. Last week’s budget deal removes short-term uncertainty from the markets, but could cause longer-term issues. The package will add significant additional short-term stimulus and boost defense spending, which could cause an increase in both economic growth and inflation. It also makes the nation’s troublesome fiscal problems even worse. Additionally, the spending package greatly reduces the risk of another budget fight, but probably eliminates any chance of an infrastructure deal.
4. Despite the market turmoil, economic fundamentals remain sound. Leading indicators and corporate earnings trends point to a continuation of the economic expansion and bull market. Warning signs to the contrary would include widening credit spreads and/or tightening financial conditions, but those have not materialized.