Tariff Talk and a More Hawkish Fed Keep Investors on Edge
For an extended period, stocks had been the beneficiary of supportive Washington policy, including deregulation, tax reform and fiscal stimulus. Monetary policy, too, was a tailwind as rate hikes were deliberate and policy remained accommodative. In the fifteen months between the election and the market peak on January 26, the S&P 500 had climbed 34 percent, and the VIX index of implied volatility averaged 11.3. But since then, the index has fallen 6.3 percent and the VIX has averaged 21, as investors have begun to worry that monetary policy is becoming a headwind, and that much of the good news on fiscal policy has already been discounted. The S&P 500 ended last week at 2691, virtually unchanged from December 22, the day the president signed the tax reform bill.
Investor Confidence Declines as Trade Antagonism Intensifies
There has always been the nagging concern among investors that the administration’s protectionist inclinations would eventually emerge. But, there also was the hope that such views would be tempered by more moderate voices, and that threats of trade wars were simply negotiating tactics. Those hopes were dashed on Thursday with the tariff announcement. The market reaction was swift, as stocks slid, the VIX rose, and bond prices climbed. Both reversed course on Friday on the possibility of an initial overreaction, but the uneasiness remained. Whether the administration softens its rhetoric and allows for exceptions to the tariffs remains to be seen, although that was not the message from the administration’s representatives over the weekend. Also uncertain is whether there will be a retaliatory response from our trading partners. But if the trade antagonism intensifies, investor confidence will come under increasing pressure.
Stocks were already under duress by the time the tariffs were announced, starting with Powell’s testimony before the House on Tuesday. Although he avoided any direct comment about future policy actions, he did aver that, in his opinion the economy had strengthened since the Federal Open Market Committee (FOMC) last released its forecasts in December, and that further gradual rate hikes were warranted. His remarks were interpreted as more hawkish than anticipated, raising the odds of a fourth rate hike this year in the process. The next indicator of the degree to which inflationary pressures are building will come on Friday, with the February employment report and the rate of increase in average hourly earnings. It was the jump to a 2.9 percent annualized rate of growth that contributed to February’s market correction. The Bloomberg consensus anticipates some further tightening in the labor market, with the creation of 205,000 new non-farm jobs and the unemployment rate dropping to 4.0 percent, but with average hourly earnings growth easing to 2.8 percent.
Investors Paying Close Attention to Eurozone Elections and China’s GDP Forecast
Election results in the Eurozone are being watched closely. The Italian election delivered no clear winner, but voters apparently showed widespread support for the Eurosceptic populist candidates, leaving the potential makeup of a ruling coalition uncertain. In contrast, it appears that Germany has finally been able to form a government led once again by Angela Merkel. In early Monday trading, stocks throughout the Eurozone are mostly higher, led by the German DAX index, although stocks in Italy are modestly lower. And China officially reiterated its 2018 economic growth target of 6.5 percent, the same as last year. However, it also established a slightly lower budget deficit target, suggesting some tolerance for a modest shortfall in the growth target.
Despite the rise in policy risk, U.S. equity investors may take comfort from the expected increase in stock buybacks and dividend increases likely to result from tax reform. As reported by the Financial Times, Goldman Sachs estimates that dividends will increase this year by 12 percent, and stock buybacks will rise by 23 percent. JP Morgan estimates that stock buybacks will increase by as much as 50 percent.
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Past performance is not a guarantee of future results.
S&P 500 Index: Is an unmanaged capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a widely used measure of market risk. It shows the market's expectation of 30-day volatility. The VIX is constructed using the implied volatilities of a wide range of S&P 500 index options.
The DAX (Deutscher Aktienindex) is an index of the 30 most actively traded German blue chip stocks on the Frankfurt Stock Exchange.
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