The stock market has been insanely volatile since late January (Fig. 1).
The S&P 500 was zigging higher at a good clip last year until it peaked at a record high of 2872.87 on January 26. It then zagged down sharply on February 2 on higher-than-expected wage inflation during January.
But February through April data showed that wage inflation remains remarkably subdued below 3.0%.
The market continues to zigzag nonetheless:
(1) Earnings. It zigs (moves higher) on good earnings reports, but zags (lower) when good earnings reports fail to cause stock prices to zig as much as expected. Compounding the confusion is the fear that “earnings have peaked,” which really means that earnings growth is undoubtedly peaking this year near 20% thanks to Trump’s tax cuts, solid global economic growth, and rising oil prices. Nevertheless, earnings should continue to grow to new record highs next year at the slower trend pace of 7%, unless there is an imminent recession, which is widely perceived to be unlikely.
(2) Trade. Then again, if a trade war breaks out, there could be a global recession, maybe even a 1930s-style depression. That’s why the market zags when Trump and his trade representatives threaten to raise tariffs, and when our trading partners threaten to retaliate.
(3) Interest rates. The market has been mostly zigging despite six Fed rate hikes since late 2015 (Fig. 2). That’s because Fed rate hikes confirm that US economic growth is sufficiently robust to absorb the hikes. So the normalization of monetary policy seems to be bullish.
Yet when the bond yield gets too close to 3.00%, stock prices zag. When they do so, the bond yield backs away from that widely feared technical level. Furthermore, when the yield curve flattens, many stock investors and strategists start to hyperventilate that it might invert, which has always been a reliable indicator of an imminent recession.
Or could it be that Fed tightening with curve flattening implies that the Fed is on top of inflationary pressures? If so, then the economic expansion could last longer, which would be bullish. That’s the zigging case for stocks for the rest of this year and beyond.
(4) Spreads. While the flattening yield spread between the US Treasury’s 10-year bond and two-year note is raising fears of a recession, the yield spread between the 10-year bond and the comparable TIPS is showing mounting inflationary expectations, which makes sense only if the economy is about to overheat (Fig. 3 and Fig. 4). Meanwhile, the yield spread between corporate high-yield bonds and the US Treasury 10-year remains remarkably subdued around 325bps since early 2017 (Fig. 5). There’s no credit crunch and recession in this spread. So should we zig or zag?
(5) Regulation. Last year started out with expectations of tax cuts. Those expectations weakened as the year progressed. Yet stocks continued to move higher, partly on the belief that the Trump administration was greatly easing the regulatory burden and oversight of businesses. Then suddenly this year, the market-leading FANG (Facebook, Amazon, Netflix, and Google’s parent Alphabet) stocks were hit by fears that Congress would move to regulate them mostly as a result of Facebook’s cavalier handling of data collected on millions of people using its platform. So the FANG stocks zagged, pulling the overall S&P 500 stock price index down. But when they delivered better-than-expected earnings, they zigged, boosting the overall market.
(6) Trump. While Fox News trumpets Trump’s domestic and foreign policy achievements, CNN covers his alleged covering up of his personal affairs. The market seems to zag when the President’s chances of getting impeached go up, until the market recognizes that he has already achieved the most he is likely to achieve on the domestic front in terms of policies that are bullish for stocks. So the market tunes out the political noise and goes back to focusing on all of the above.
Conclusion: Get a neck brace. Once some of the noise about the issues above dies down, the market should focus on the clearly bullish signal coming on the earnings front.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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