Schwab Market Perspective: Teflon Market

Key Points

  • Stocks resumed their rally in the immediate aftermath of the Fed's decision to raise rates at the March FOMC meeting. Volatility remains remarkably low but that doesn't mean it won't pick up—investors should be prepared for bouts of volatility, and pullbacks along the way.
  • The U.S. economy continues to expand; although there are signs that first quarter growth could be on the weak side, largely due to continued seasonal issues. We believe that economic growth is generally accelerating, a thought bolstered by the Fed's confidence to raise rates again.
  • Politics, both here and abroad, are keeping policy uncertainty high and should also contribute to bouts of volatility.

Calm, Confident…Complacent?

Nothing seems to be able to phase the stock market recently. Political infighting, Presidential tweets, North Korean missile launches, oil falling below $50, European political uncertainty, higher bond yields, and the Fed raising rates: none of those forces have knocked stocks off their recent uptrend. Volatility has remained remarkably low for an extended period, and the S&P 500 hasn't seen a 1% down day since October 11, 2016—the second longest span in history. Remarkably, at this stage of the eight-year bull market (reached on March 9), stock gains have accelerated in recent months while volatility has declined.

Volatility remains low

Volatility remains low

Source: FactSet, Chicago Board Options Exchange. As of Mar. 14, 2017.

As stocks continue to move higher

As stocks continue to move higher

Source: FactSet, Standard & Poor's. As of Mar. 14, 2017.

Just when we were starting to get concerned about the potential of a true "melt-up" in U.S. stocks, the indexes trended sideways to slightly lower during the first two weeks in March, allowing the prior gains to be digested, and for sentiment conditions to ease a bit. According to the Ned Davis Research (NDR) Daily Trading Sentiment Composite, investor sentiment moved back into neutral territory recently, easing concerns about a near-term, sentiment-driven pullback. But is this the calm before the storm?

This period of calm isn't going to last forever, and we caution investors to remain disciplined around diversification and rebalancing. Part of the reason for the depressed volatility may be the rise in passive investing—index funds don't move in and out of stocks nearly as much as actively managed funds do. That trend may be reversing, which would likely increase volatility (read details of our thinking at "Radioactive: Is Passive's Dominance Over Active Set to Wane?" by Liz Ann Sonders). Additionally, political rancor, foreign election uncertainty, geopolitical tensions, and a more hawkish Federal Reserve all have the chance to contribute to a pullback. We have made a couple of moves in an attempt to allow portfolio gains from stocks to continue, while potentially providing a bit of a buffer against the possibility of an uptick in volatility. We remain overweight to U.S. stocks as we believe the bull market continues, but we recently shifted to a large cap bias (read details in "Big Machine: Why Large Caps Are Likely to Outperform"). Additionally, on the sector front, we added the health care sector to our outperform ratings, adding the potential of a little defense in a largely cyclically-bullish tactical bent (read more about health care here).

Well-deserved confidence?

While there may be pockets of complacency, the recent market run and accompanying higher confidence among business, consumers and investors appears well-founded by economic fundamentals, which supports our belief that the secular bull market has further to run. Confidence spikes have been seen in both the National Federation of Independent Business (NFIB) small business confidence and the Conference Board's consumer confidence indexes. In addition, the forward-looking new order components of both the ISM Manufacturing and Non-Manufacturing Indexes spiked higher in the most recent readings (65.1 and 61.2, respectively—with values above 50 indicating expansion). And the "hard" data is now starting to confirm the "soft" (survey/confidence-based) data. The February retail sales report showed a 0.2% increase, excluding autos and gas, while January's reading was revised higher. The labor market also remains strong, with ADP reporting a surprising 298,000 new jobs in February and the Labor Department reporting 235,000 jobs were added; while the unemployment rate fell to 4.7%.

One recent concern has been the weakening of the Atlanta Fed GDPNow survey, which currently predicts first quarter gross domestic product (GDP) growth to be a tepid 0.9%.