- Geopolitical, U.S. political and "bubble" concerns rose recently, putting a dent in the market's recent run. U.S. political turmoil is likely to keep market volatility elevated in the near term, but we believe the bull market still has legs.
- U.S. economic growth continues to be fairly healthy, and earnings season was positive for both bottom- and top-line growth; lending support to the bulls. But the storm in Washington is picking up velocity, especially as the upcoming debt ceiling fight looms large.
- Asia has been the center of recent geopolitical unrest but stocks in the region have largely followed corporate fundamentals.
A couple of weeks ago we wrote in this space how the odds of a melt-up were increasing, as nothing seemed to dent the upward trend in stocks. What a difference a couple of weeks can make. The wall of worry that we were concerned was eroding has been at least partially built back up, and the uptrend took a hit. As a result sentiment conditions have corrected from overly optimistic levels based on most of the traditional metrics. In addition, the volatility index (VIX) spiked, rapidly pulled back, and spiked again—reminding investors that conditions can change quickly.
Source: FactSet, Chicago Board Options Exchange. As of Aug. 14, 2017.
The first brick in the rebuilt wall was an increase in the warnings of "bubbles" forming. From former Federal Reserve Chairman Greenspan telling CNBC that a bond bubble was brewing, to warnings from various other pundits that housing, tech stocks, and/or the overall stock market were in bubbles—the warnings increased over the past couple of weeks. Perhaps the warnings themselves helped alleviate overly-optimistic sentiment. We are again reminded of one of our favorite quotes from one of the titans of finance, Sir John Templeton, who opined, "Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria." We have argued for some time that this bull market has been one of the least respected in history, with skepticism remaining high among investors—helping the bull market to persist. But we are mindful of the growing risks and believe the market could struggle in the near-term. Even before the latest selloff, market breadth had been deteriorating and we are in the midst of a period of typical-seasonal weakness. For now though, we believe any corrective phase is in the context of an ongoing secular bull market. The first significant reversal occurred when rhetoric surrounding North Korea ramped up with nuclear threats from Kim Jong Un and President Trump's "fire and fury" volley back. As of now it looks like North Korea has backed down and investors have breathed a sigh of relief; but attention is now on the drama in the Trump administration and growing concerns about getting pro-growth policies passed, which has contributed to another sizable pullback in the market.
No bear in sight
Ultimately, we think traditional fundamentals will define market behavior. After a weak first quarter, U.S. economic growth has rebounded, with an improving employment picture, tightening labor market, rising median wage growth, and a relatively healthy consumer. Even though past performance is no indication of future results, a prolonged bear market has never occurred outside the context of a recessionary environment. Looking at the Index of Leading Economic Indicators (LEI) from the Conference Board, there are no signs of a coming recession.
Source: FactSet, U.S. Conference Board. As of Aug. 14, 2017.