Don't Mistake the Stock Market for the Economy
The gut-wrenching moves in equities in recent days raise a number of questions. For one, are the declines indicative of an underlying problem in the global economy? And two, do the losses threaten to spark some sort of contagion?
It's still early days, but the answers lean toward a strong "no." What's notable about the selloff, which has seen the MSCI All-Country World Index drop as much as 10.7 percent from its highs in January, is that there hasn't been a mass grab for havens. Yes, U.S. Treasuries were in demand Monday, but that reversed somewhat Tuesday. And, other assets favored in times of turmoil have barely budged.
At about $1,335 an ounce, gold is actually down from its highs last month of $1,358. In the currency markets, a Bloomberg index of the yen against the dollar, euro, pound and six other major peers is hovering around its lowest levels since early 2016. Measures of stresses in the banking system such as the Libor-OIS spread are little changed over the past month, suggesting no one is worried about banks getting in trouble.
The tumble in stocks is being attributed to a range of causes, including the unwinding of what could be almost $2 trillion in bets tied to low volatility, signs of faster inflation, hawkish central banks and higher bond yields. That may all be true, but it's just an excuse for investors to take a bit off the table at a time when there's been much concern about high valuations and complacency. Remember: the S&P 500 Index had gone a record 404 days without a 5 percent drawdown.
Just two weeks ago, the International Monetary Fund raised its forecast for global economic growth this year to 3.9 percent, up 0.2 percentage point from its projection in October. That would be the fastest rate since 2011, when the world was bouncing back from the financial crisis. Despite a minor pullback last month, global economic data are beating forecasts by a healthy margin and at a pace that corresponds with stronger growth. Foreign-exchange reserves for the 12 largest emerging-market economies, excluding China, have risen to $3.17 trillion from less than $2 trillion during the financial crisis, providing an ample cushion if times get tough, according to data compiled by Bloomberg.
Corporate earnings are hopping. Through Feb. 2, 251 of the S&P 500 companies had reported results for the fourth quarter and 77 percent beat expectations, according to Bianco Research. Should this level hold, it will be the highest of the post-crisis period. There's more: Year-over-year operating earnings growth now exceeds 15 percent and analysts have increased their forecasts for full-year 2018 earnings to 20 percent, according to Bianco. The company notes that even though the S&P 500 was up 26 percent between Jan. 1, 2017, and Feb. 2, 2018, stocks are the cheapest they have been in a year based on price-to-earnings ratio using 12-month forward earnings estimates.
The markets went through something similar two years ago, when concerns about a slowdown in China's economy and high debt levels there sent the MSCI All-Country World Index down 1.93 percent in December 2015 and 6.09 percent in January 2016. Although U.S. gross domestic product came in at a sluggish 0.6 percent in the first quarter of 2016, it soon rebounded to above 2 percent growth for the following two quarters.
As Evan Brown, the New York-based director of asset allocation on the investment solutions team at UBS Asset Management, told Bloomberg News on Feb. 2: "The underlying strength of the economy is still healthy. The overall level of interest rates is still quite low. If anything, we’re surprised that it took so long for us to get a 3, 5 percent correction in the market."
Bull markets end when economies go into recession, not because of high valuations. There's nothing on the horizon to suggest the economy is on anything but stable ground. Violent fluctuations, however painful, happen, but history shows that the fundamentals ultimately prevail.
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