Prepare for higher volatility ahead
PillartoPost.org feels it is important for the average American to obtain as much information on the workings of the current stock market. In that spirit we present the view of this blog’s financial advisor —not as an advertisement but simply her view on what is happening in this rapidly unpredictable financial marketplace.
GUEST BLOG / By Nela Richardson, Ph.D, Investment Strategist, Edward Jones--Stocks started off 2019 with more turbulence, but finished higher for the holiday-shortened week. The combination of a profit warning from Apple, which cited weakness in China, and a softening in the ISM manufacturing index raised concerns over the impact of slowing global growth to the U.S. economy.
However, the strong jobs report released on Friday, along with some trade optimism, eased those concerns. The U.S. economy added 312,000 jobs in December, the most in 10 months, which, in combination with faster wage growth, points to continued support for consumer spending, the biggest driver of U.S economic growth.
We believe the fundamental investment backdrop is still more favorable than short-term moves and headlines might suggest, but investors should prepare for higher volatility ahead as expectations for global growth and corporate profits are recalibrated.
Harmonizing Earnings Growth and Market Volatility
After a harsh start to the new year, equity markets ended the week on a high note. In the first two trading days of 2019, the Dow lost 641 points, only to rally another 748 last Friday. These broad swings are indicative of the late stages of a bull market, and while we expect growth to continue, the ride is likely to be rockier.
Just as every song has three components (melody, harmony and rhythm), equity returns are driven by three elements: economic fundamentals, investor sentiment and valuation. Here’s why Edward Jones expects share prices to stay in tune and grow in 2019, albeit with the potential for some high and low notes.
Although growth has likely peaked, economic fundamentals remain solid.
The December jobs report released on Friday delivered a powerful reminder to investors that economic fundamentals are still strong enough to support higher equity returns in 2019. The economy created a very strong 312,000 jobs last month, the seventh largest monthly increase over the nearly 10-year expansion and well above an expected gain of 184,000. The previous two months were revised upward, bringing the three-month pace of jobs created to a robust average of 254,000. Wage growth, which has stalled for most of the last 10 years, jumped 0.4% in December, bringing the year-over-year total to 3.2%, its largest pace since 20091.
Labor market participation, which has slumped over the decade, also ticked up. Even the slight rise in the unemployment rate to 3.9% from 3.7% signaled good news as more consumers who had been sitting on the sidelines saw attractive opportunities and jumped back into the labor market. Robust job creation and wage gains could bode well for continued strength in consumer spending and, since consumers are two-thirds of the economy, could help alleviate some concerns of an impending recession.
Not all of last week’s economic data releases were good, however. A gauge of manufacturing conditions decreased in December based on a sharp decline in new orders, signaling weakening demand for U.S.-manufactured goods. Similar manufacturing data in China suggesting slower economic growth, combined with market anxieties and recession concerns, prompted a selloff earlier in the week. These mixed economic signals are consistent with our outlook for slower but modest economic growth for the year.
Market sentiment changes its tune with the Federal Reserve.
Over the last three months, continued debate over the direction of interest rates and Federal Reserve policy has led to wide swings in the markets. In response to a growing economy and rising inflation, we expect the Fed will continue to slowly increase short-term interest rates while likely pausing at some point over the course of the year.
This past week, investors cheered comments by Federal Reserve Chairman Powell that the Fed would remain patient and flexible if slower economic conditions warrant fewer rate hikes. The No. 1 concern for investors is that the Fed will increase rates too far, curtailing economic growth and prompting a recession. Interest rates are likely to remain a key focus of the markets, and volatility will likely continue, but below the surface, the economy remains fairly healthy in our view.
Valuations: Volatility creates opportunity.
Over the course of 2018, the price that investors were willing to pay for a dollar of future earnings, known as the forward price-to-earnings ratio, fell from 20 to 15.2 times for the S&P 5001. As Apple illustrated in its note to investors last week, companies may be facing headwinds from tariffs, higher supply costs and rising interest rates.
Our outlook is for earnings to continue to grow in 2019, but at a slower pace than the more than 20% growth experienced last year. In our view, earnings growth that is in line with historical averages (5% to 7%) will support continued increases in share prices. The takeaway for investors is that the current market provides an attractive opportunity to buy stocks at lower prices, in our view. We believe this is also a good time to consider diversifying your portfolio and investing internationally into developed large-cap funds with both higher dividend yields and lower relative valuations than U.S. large-cap stocks.
Staying In Tune With the Market
Last week’s market swings demonstrate that the key to successful long-term investing is being able to hear the entire piece of music and harmonize the economic fundamentals, investor sentiment and valuation to meet your important long-term financial goals, regardless of the level of market volatility. By understanding what’s most important to you, your financial advisor can help you become your own music conductor and orchestrate personal investment strategies.
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