The Independent Market Observer

Market Down Again, But Signs Remain Positive

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Jun 26, 2018 3:10:55 PM

and tagged Commentary

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marketYesterday was a bad day for the U.S. stock market. But is it time to worry yet? The short answer is, “probably not.” “Not” because the economic and earnings fundamentals remain sound. “Probably” because the slow progression of trade worries may be starting to shake market confidence. The longer answer, however, gets more into the details.

The fundamentals

Job growth is strong. Consumer confidence is high, so the largest part of the economy is able and willing to grow—and is doing just that. Plus, business is confident and investing. Companies are making lots of money. In short, all of the ingredients for a buoyant stock market are there.

On the other hand, there are increasing concerns that things are slowing (concerns that I share) and that policy, especially trade, may cause serious economic disruption. Although the fundamentals are sound, current high market valuations are based as much on confidence as on those fundamentals. Should confidence take a knock, markets could follow.

The questions we have to ask right now are whether the worries about the fundamentals are real, whether the worries about policy risks are real, and, if so, could those actually shake confidence in a meaningful way?

Economic risks

For the economic fundamentals, there are signs that things may start slowing. But current growth is actually accelerating, so the potential slowdown doesn’t look like an immediate risk. One of the highest-profile concerns is the yield curve (i.e., the difference between long-term interest rates and short-term interest rates). Specifically, the yield curve looks like it might be inverting, which is a sign of a pending recession. This is something to watch, certainly, but it hasn’t yet inverted and might not for a while. Even when it finally does invert, there is typically a 12- to 18-month lag between the inversion and when the recession starts. The economic risks, while real, are therefore not something that should rock markets any time soon. In fact, we have seen the economy act as a market cushion. This is actually a sign not to worry yet.

Policy risks

Next, is the worry about policy risks (i.e., trade) real? Here, the news is more concerning. The progression of threats and actions between the U.S. and other countries is indeed raising global risk—and has the potential to do so even further. This is a real potential concern, as we saw yesterday. Even here, though, the U.S. economy is much less exposed to trade than other countries are, and the direct economic damage would likely be small and delayed. More, despite the concerns, the likelihood is that the trade disputes will be resolved in a less damaging way than the market now fears. From an economic perspective, trade is therefore something to watch but not an immediate concern.

Will confidence break?

With fundamentals sound, the big risk to markets is that confidence—the belief that as good as the economy and markets are now, they can continue to get even better—will break. That is the threat that trade disputes pose to financial markets.

While this is not a fundamental concern, it is a real and potentially significant issue, and it could show up quickly. Here again, though, signs remain positive. The U.S. stock market remains in an uptrend, well above risk levels. Even bad news has persistently failed to knock the market down in a significant way. Indeed, yesterday’s decline, while distressing, is still within normal ranges; therefore, it is probably nothing to worry about.

Signs remain good

Overall, concerns are indeed rising. But so far, at least, the fundamentals have limited any market risk and are likely to keep doing so. Confidence, while potentially at risk, has shown remarkable resilience. This is a trend that has shown no signs of changing. For now, then, the signs remain good. But we will keep watching—just in case.

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