If Wall Street’s new-year mantra was “feel the fear and buy it anyway,” fresh economic and market anxieties are testing the bullish resolve.
After the best start to the year since 1987, investors returned from the long weekend in a gloomy mood. The S&P 500 Index posted the biggest drop in almost three weeks on Tuesday while the Cboe Volatility Index jumped the most in a month.
For Wednesday’s rally to endure and skeptics to capitulate, money managers have to climb a mounting wall of worry -- including the durability of the economic upturn, policy paralysis, threats to corporate earnings and the interminable trade war.
“I wouldn’t think the worst is behind us,” said Ian Samson, an investment analyst at Fidelity International. “You can maybe make valuation arguments in a lot of asset classes that got really beaten up last year, but it’s hard to make fundamental arguments for things getting much better.”
Take economic expansion. One narrative surrounding the fourth quarter sell-off and subsequent rebound is that markets became too pessimistic on growth -- at their nadir, asset prices were underpricing economic activity as well as prematurely fretting recession.
But ill omens are stacking up. The Bloomberg U.S. Economy Expectations Index slumped to its lowest level since November 2016 last week while the Empire manufacturing survey fell to the lowest since May 2017.
Lest anyone think those readings were anomalies, bear in mind January began with the ISM manufacturing release printing at the weakest since 2016. The Markit PMI equivalent sunk to its lowest since September 2017.
“We are at a stage in the economic cycle where macro and political uncertainty have the potential to make or break consensus trades very quickly,” said Arif Husain, head of international fixed income and a portfolio manager at T. Rowe Price.
Global leaders in Davos who are talking -- and skiing -- at the World Economic Forum, take note: Policy angst is also weighing on financial conditions and, in turn, threatening growth.
“Elevated policy uncertainty around the world poses a growing downside risk,” Goldman Sachs Group Inc. strategists led by David Kostin wrote in a note.
A popular gauge shows discord in this regard is at a record high, especially across Europe and the U.S., as divined by text searches of local newspaper articles.
“It’s not the time to set a position and relax for the rest of the year,” said Karen Ward, chief EMEA market strategist at JPMorgan Asset Management. “There’s too much geopolitical uncertainty which could go one way or the other and change the outlook dramatically.”
Another lurking monster: The partial government shutdown in the world’s largest economy is now entering a record 33rd day.
Strategists at JPMorgan Chase & Co. including John Normand tracked the impact of about 20 previous closures over the past last half century. They tended to last between one and three weeks and clipped on average from 2 to 3 percent from equity prices.
But gauging the impact of this shutdown is proving difficult because the fate of U.S. risk assets seems inextricably linked to the outcome of trade talks with China.
True to form, the S&P 500 extended losses on Tuesday afternoon when the Financial Times reported the White House had rejected an offer for preparatory talks with Chinese officials. Economic adviser Larry Kudlow subsequently said a high-level meeting remains on track for the end of the month.
To cap it off: Corporate results also present all manner of risks. Analysts have spent most of the past month lowering their earnings expectations, and now see a 12 percent increase for the fourth quarter -- half the pace of the prior period.
“For the current rally in risk assets to sustain itself then we need to have a positive earnings season and we need to have some positive economic data,” David Riley, chief investment strategist at BlueBay Asset Management, told Bloomberg TV.
Normand and co. at JPMorgan reckon stocks will prove more resilient to any softness than in prior quarters, and along with positioning and depressed valuations that means the S&P 500 can rally to 3,000 this year from just over 2,600 now.
Yet there is less-encouraging anecdotal evidence from some of America’s most high-profile businesses. Revenue and sales at Netflix missed projections. Apple cut its forecasts. Johnson & Johnson issued lower-than-expected financial guidance. And companies reporting disappointing estimates this season are being punished with uncommon force.
Still, there’s always the Fed, right? Bets on a dovish tilt have certainly helped spark the equity rebound, after monetary angst last month also jumped to mid-2016 highs, according to an index tracking the level of uncertainty on Federal Reserve policies.
That suggests markets remain acutely vulnerable should hawkish monetary fears resurface.
The bottom line is, the uncertainty that has plagued the new-year rally remains eminently defensible. And that could prove its downfall.
As Kostin and his team at Goldman note, “Regardless of realized growth, elevated uncertainty may keep investors from continuing to re-risk.”
--With assistance from Mark Cudmore, Francine Lacqua, Tom Keene, Joanna Ossinger and Elena Popina.
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