Investment markets live up to their reputation for periods of volatility, especially in recent weeks. But the uncertain economy has tremendous potential for damage. When the S&P 500 index falls along with the Dow Jones Industrial Average and the Nasdaq Composite is off 2.3%, it feels pretty bad. But when each index is down more than 3% and the consumer price index (CPI) more than quadruples, it becomes impossible to predict the market outcome.
Inflation has jumped much higher than expected, while payrolls are well below forecasts. Predictions for inflation and employment data weren’t even close. The CPI in March rose 0.5%, only 0.1% higher than expected, but payrolls were off by hundreds of thousands. In a stable economy, anticipated numbers might be off by 50,000 at the very worst.
We know the stock market is volatile but didn’t expect it to vary this much in the U.S. economy. The pandemic changed everything. Variations would typically be minor, deviating from one standard above or below average. But personal-consumption expenditures are now 5.5 standard deviations above average, something we didn’t experience during the global financial crisis of 2008. It’s challenging to predict what will happen next.
The Federal Reserve Chairman Jerome Powell and the Fed governors have a tough job deciding which views on inflation are accurate and whether to wait for the first rate hike until 2024. The answers are certain to impact the market with even more volatility.
Up to now, the Treasury market has been fairly stable. It remains range-bound and the ICE BofAML MOVE index tracking the volatility of the Treasury options market remains constant. If the Fed slows its bond purchases, volatility could create a domino effect in other financial markets.
The Changing Landscape
Global and national economic factors significantly contribute to the direction the market takes and influences volatility. Changes in tax and interest rate policies, inflation, industry, and sector factors affect short and long-term stock market trends.
Between vaccination rollouts being ahead of schedule and trillions in stimulus packages, the economic outlook has improved significantly in recent months. It has shifted dramatically from predictions in December 2020 to potentially reaching the GDP forecasted growth of 6.5%. Employment numbers are the weak point in recovery and may not return to the pre-crisis rate until the second half of 2023. The expected spike in inflation in second quarter 2021 may prove transitory. This should keep the Fed on hold until late 2023 and reduce the risk of recession over the next 12 months to 10% to 15%, down approximately 10% since January.
Higher rates and yields appear to be balanced. As long as we see higher growth and earnings expectations, inflation may not be a big concern. While transitory inflation will be due to the U.S. stimulus plan, gaps in economic output should close as the labor market tightens and the Federal Reserve lowers inflation back to its target.
The Fed could underestimate inflation and wage responses to the stimulus and raise rates quickly. If it does, U.S. economic recovery could slow, causing market volatility that would affect other economies. Differences across sector recoveries could slow growing earnings putting firms under stress as funding rates rise. The disparity in rebound rates between the U.S. and the rest of the world could open up interest rates and growth caps and challenge emerging markets as higher U.S. rates leak into their domestic funds. Recovery can come from orderly reflation.
Governments continue to accommodate with monetary policies that are more than expected. Major central banks are responding to actual wage and price pressures rather than predictions. As inflation increases and unemployment lowers, it will introduce two-way investment risk in these variables.
Riding the Wave of Economic Volatility
Potential for increased volatility and market corrections might send us into a bear market if it weren’t for growing global earnings anticipated to increase at a rate of 36% this year. It‘s common to see a big increase at this stage of a bull market. When earnings are growing by 25% or more, the stock market usually has a good year similar to the positive returns reported in 2010. This indicates that 2021 should be okay despite worry about slowed growth in 2022.
Growth stocks can recover as long as they have earnings. Large growth selloffs with free cash flow and expanding margins should outperform in the months ahead. Research carefully and gain the advice of investment managers, or you could be in for more than just a little volatility.
Getting back to some sense of normalcy depends on what the post-COVID economy looks like and how quickly we get there. We are not likely to achieve an end-2019 world but a restart instead. Goals and preferences have changed and altered the composition of production and consumption. The market and economy are still uncertain.
At Clearbrook Global, we have gained more flexible workplaces, increased technology, and created a greater focus on health security and social contracts. We believe while socially interactive sectors reinvent themselves, flexible markets and policies can ride out the economic volatility and market transition. By keeping an eye on financial trends impacting the market, we can advise you on investment strategies as you navigate this uncertainty. Contact us anytime.
Sources:
Gruenwald, P., 2021. Global Economic Outlook Q2 2021: The Recovery Gains Traction As Unevenness Abounds, https://www.spglobal.com/ratings/en/research/articles/210331-global-economic-outlook-q2-2021-the-recovery-gains-traction-as-unevenness-abounds-11897677
Levisohn, B., Stock Market Volatility Isn’t the Big Problem. This Is, https://apple.news/AWEJy3UT6Qxq8SDZBP6XzAQ