TO SUMMARIZE OUR THOUGHTS 3/31/2018
There is an inverse relationship between volatility and liquidity. Volatility decreases when the Fed adds liquidity to the system, and volatility increases when the Fed withdraws liquidity. The Fed has steadily raised rates almost 2%, and has quietly been tapering its balance sheet, thus volatility has reemerged from its historic hiatus.
Corrections are always unnerving, but market corrections of 5-10% occur with relative frequency. Bad things can happen in good markets. Following a parabolic move in January, we view recent price movement as a correction toward trend rather than a broken market. The U.S. economy doesn’t appear anywhere close to a contraction, which has historically accompanied true bear markets, and traditional stock market fundamentals continue to remain supportive of the lumbering bull market.
As we contemplate the current phase of the economic cycle, we believe the full benefit of the tax cuts have yet to make their way through the economy, and we our encouraged by the recent strength of corporate earnings. Combined with the recent pullback in stocks, valuation pressures have eased.
While we anticipate a strong economy and robust corporate earnings to push the stock market up from current levels, we know it will do so in a more volatile fashion. With that said, two primary factors that would have a dramatic impact on markets if they came to pass would be an overzealous Fed and an actual trade war with China.
All early indications are that the current Fed, under new Chairman Powell, is unfazed by market volatility. However, if inflation remains benign, there is little reason to believe the Fed will stray from its well communicated plan to normalize monetary policy. While China headlines are unsettling, we believe the realities of interdependence will discourage the first major trade war of the last 90 years.