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Risk On, Risk Off

April 10, 2018, 10:44 am

Wall Street started the second quarter much the same way it ended the first. Investors came back from the holiday break in a wary frame of mind, and while the mood brightened considerably, we had a ways to go before investors could get past the headlines. That triggered a lot of volatility, so I thought now would be a good time to talk about what set the selling off.

Last Monday, the market was down on a variety of factors, including a soft ISM number, news that China is imposing tariffs on 128 U.S. products and President Trump’s continued tweeting onslaught on Amazon (AMZN), which knocked the stock another 5% and dragged the NASDAQ down along with it.

We also saw another round of rotation from Big Tech back to more defensive themes: consumer staples, real estate, utilities and Treasury debt. These areas are still battered on a year-to-date basis, so headlines around the FAANG group – Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX) and Alphabet (GOOGL) – and similar Big Tech giants are largely an excuse to capture some of that exposed data.

Last Friday’s selling started overnight on news that President Trump wants to add another $100 billion in Chinese imports to the tariff list, and it accelerated when Federal Reserve Chairman Jerome Powell failed to tell markets what they wanted to hear about interest rates in the wake of a fairly cool monthly employment report.

Even after three big up days in the middle, Friday’s retreat left the S&P 500 back within sight of Monday’s low and down 1% from the previous Thursday’s pre-holiday close. Losing 1% in a week is relatively small – and not even half the loss investors faced on Monday – and the biggest red numbers have been concentrated in a handful of companies. At one point, the biggest drags on the market were actually showing a net weekly gain, which illustrates both how fast the pendulum can swing and the current tension between gloomy headlines and the strongest corporate fundamentals in years.

Earnings will be important going forward. They are on track to grow 18%-19% above last year’s levels, and with revenue likely to climb 6%-7% as well, the biggest U.S. corporations have plenty of room on the top line to clear any new trade policy hurdles. Moreover, stocks look cheaper relative to those anticipated earnings now than they did a year ago.

Those fundamentals haven’t gotten any worse since the S&P 500 peaked back in January. Expectations have actually brightened by a wide margin, and I suspect that once earnings season picks up speed late next week, Wall Street will find it harder to sell stocks. In addition to the growth, valuations have gotten more attractive with the combination of lower stock prices and an earnings growth ramp. We’re now a long way from bubble conditions or even an overheated market.

This week’s earnings and news flow might give a lot of investors who stepped aside enough confidence to come back. That’s not to say the volatility will go away, but the strengthening economy and growing earnings will at some point make lower stock prices too attractive to pass up.

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