This is Keith Lerner, Chief Market Strategist for SunTrust Advisory Services Inc. with an updated market outlook in light of the recent volatility. So here are the 3 things we will cover today:
1. Our 2018 Equity theme of Bullish but Bumpier remains intact
2. We will share our perspective on volatility, tariff uncertainty and the technology sector
3. While risks remain, the correction we have seen has served to alleviate some of the market excesses and we would lean into the weakness.
Let’s begin by taking a step back and put the recent market action into perspective with a chart that shows the S&P 500’s path since 2009. What we see here is the market has gained 325% since March 2009. But it’s not been a straight line. We have had 16 pullbacks of at least 5%, highlighted in red. This shows almost every year something happens that creates uncertainty. Corrections are the admission price to the stock market
However, last year, which is shaded in green, was very unusual in that the deepest pullback was less than 3%. Low volatility years like 2017 are almost always followed by higher volatility years and more modest stock gains. This is one of the reasons why we anticipated a bumpier stock market this year.
Another way to look at volatility is simply counting how many days trade up or down by 1%. Since 2009 we have averaged about 60 1% days. So far this year we are up to 27. However, this feels magnified because in 2017 we only saw 7 up or downs of 1%.
Now let’s talk about 1 of the main concerns driving the volatility: Tariffs
The first important note is so far the figures that are being discussed are mostly proposals and will not be implemented for some time, if at all. The other important consideration is the amount of fiscal policy dwarfs the potential impact of tariffs @ 800 bln vs. 81.5 bln. Now the tariff # is likely to move and this uncertainty poses downside risk to the market and economy.
But keep in mind, when the White House first announced tariffs on steel, it said no countries would be exempt. However, now the majority of them are. We do believe that the administration is serious about China but this is also likely part of a process and negotiation. Still, these headlines are not going away and will continue to drive day-to-day market actions.
Another issue that has weighed on market recently is the technology sector as many of the high fliers have been hit on privacy concerns and other geopolitical consideration. As you can in this chart, the technology sector has grown to represent a quarter of the S&P 500’s weighting, so how they perform has a great impact on the overall market. However, the sector’s earnings contribution is also very high, unlike during the technology bubble and valuation are only slightly higher than the broader-market.
Moving on, the good news from this recent correction is it serving to relieve many of the concerns investors had coming into the year.
1) For example, after a very strong 2017 and one of the best Januaries, stocks became overextended. This is no longer the case as stocks are now back in line with their price trend.
2) Valuations have also reset lower. As prices have corrected, earnings have continued to rise, which means the valuation of global equities is below 15x for the first time in two years.
3) Similarly, the S&P’s Price-to-earnings ratio has dropped to the same level we war around concerns of Brexit and the US elections.
4) If trade tensions rise, stocks should see strong support around a 15 P/E, where investors stepped in during china concerns in 2015 and 2016.
It’s also important to recognize that the recent market action is very consistent with what we have seen following other sharp corrections to include the 2010 flash crash, 2011 US debt downgrade, and 2015 and 2016 china concerns. A battle between fear and greed is underway. This tug-of-war tends to be a process measured in months. Eventually, we anticipate this will be resolved with higher prices.
Also, the graph here shows how sharp the subsequent rallies have been during this bull market once the market is over. That is average gains over the next year have been above 20%. Our point here is not to imply gains will be that strong, but the turns are often swift and difficult to time. The final point: how to deal with uncertainty. Diversify. For example, government bonds have risen in 22 of the 24 year years that we have seen stocks down.
To wrap up: we are sticking with our bullish but bumpier theme, we see more upside than downside from current levels, would lean into this weakness as opposed to selling into it. Also, periods like this reinforce the importance of remaining diversified. We thank you for watching and for entrusting SunTrust with your wealth. Please reach out to your SunTrust advisor to discuss how our outlook may impact your personal portfolio. We look forward to keeping you informed on our investment views as the year unfolds.
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