What Is the Market Really Saying?

After a couple of posts on risky business (the Brexit vote and negative rates), let’s take a step back and look at the big picture. It’s easy to get caught up in individual stories, but we need to understand how they fit together—and what the market is saying about it all.

To recap a bit:

• U.S. employment growth has slowed dramatically over the past several months.
• Britain is voting on whether or not to exit the European Union in just over a week.
• Interest rates around the world have dropped to multi-century (yes, you read that right) lows.
• Corporate revenues and profits have rolled over and declined for several quarters in a row.
• The U.S. presidential election has introduced a level of policy uncertainty that we haven’t seen in my lifetime.
• Chinese investment is dropping, and the currency is starting to depreciate again.

Am I missing anything?

Probably, but that list makes the point. There’s a lot going wrong in the world, all of it widely discussed and worried about. Given the many risks, and all of the hype, I would expect the market to react sharply. And it has. Over the past six months, the S&P 500 is up just under 2 percent. Over the past three months, it’s up slightly more than 3 percent. And over the past month, it’s up a little less than 2 percent.

Plenty of concerns, but markets don't seem terribly worried

With all of the bad news, you’d expect a sharp downward adjustment. And beneath the surface of those deliberately cherry-picked numbers, that's just what we got, with a 15-percent drop in January and February. Although the worries then were slightly different, they were just as real, and the market did indeed react—before bouncing back sharply.

Why the bounce, and what does it mean for today? I would argue that stock market pullbacks tend to be short and sharp when the fundamentals are solid, as they are right now. Confidence was clearly shaken at the start of the year and then returned. Despite recent concerns, that confidence remains intact.

How do I know? Simply because U.S. markets haven’t reacted much, if at all, to the current round of worries. Brexit, while a real potential issue, clearly isn’t worrying investors here. Nor are the recent weak employment growth numbers. Nor are corporate revenues and profits, the presidential election, or anything else. The U.S. stock market just continues to cruise along.

Major rupture not likely in the short term

Much has been made of the markets’ failure to reach new highs for the past couple of years. Given the decline in revenues and earnings, however, as well as other worries, that failure makes perfect sense. The market shouldn’t be hitting new highs under current conditions. What it should be doing is dropping to more reasonable valuation levels.

The fact that it continues to hover, rather than go down, is what investors should be watching. And the fact that it bounced right back from the most recent correction is what investors should be trying to explain.

There seem to be powerful forces supporting market valuations and driving them back up when they drop. I suspect that low interest rates are a big part of that; there simply is no alternative to stocks for many investment needs. A flight to safety in U.S. assets is probably another big part. Continued economic growth, and employment growth, is another reason. Continued central bank stimulus is another. Continued low oil prices are another.

For all the reasons the economy, or the market, could crack, there are just as many suggesting that isn’t likely, at least in the short term. The big picture is telling us that the market understands this and is reacting accordingly.

Despite all of the items on the worry list, it pays to keep an eye on the positives as well. The market is usually a pretty good indicator of how those net out. For the moment at least, it’s not flashing the panic signal. Keep that in mind as you read the papers.