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Three reasons why stocks are sideways

The Fed is getting out of QE, and earnings growth and China’s economy have slowed.

  • By Jurrien Timmer, Director of Global Macro for Fidelity Management & Research Company (FMRCo),
  • Fidelity Viewpoints
  • – 04/11/2014
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Since the beginning of the year, the U.S. stock market has gone exactly nowhere. On January 1, the S&P 500® stood at 1,850, and that’s just about where it is today. What’s going on? I think there are three reasons why stocks have traded sideways for the past three months, and why they may well continue to do so in the months ahead.

Reason 1: The Fed is getting out of QE.

First of all, it is clear that the Fed is now trying to get out of the QE business. It has tapered three times at three FOMC meetings, and, at this pace, it will be done with QE by the fall. On top of that, the Fed recently gave some guidance as to how long a “considerable period” is between the last taper and the first tightening. Fed Chair Janet Yellen suggested that it could take about six months for the Fed to start raising rates after QE has ended. That brings us to the spring of next year.

That’s not to say that the Fed is going to be hiking rates in a dramatic fashion, of course; far from it: I suspect that the Fed will be cautious to not risk undermining the economic recovery by raising rates too quickly or by too much. Indeed, this is evident in the bond market, where the 10-year Treasury yield remains quite low, at 2.7%.

But it does put a more concrete time frame around the interest rate normalization that will inevitably follow the last six years of extraordinary monetary accommodation by the Fed. This should be considered good news for the economy and for equities, but nevertheless it’s an adjustment for a market that has gotten used to a continued dose of low rates and ample liquidity from the Fed. This is one reason why I think the stock market may tread water for a while.

Reason 2: Earnings have slowed.

The second reason is that earnings growth has slowed into the single digits, and P/E ratios have risen into the high teens. That on its own does not have to be a deal breaker for stocks, but it comes on the heels of a huge 32% rally last year amid only 5% earnings growth. In fact, over the past five years, the S&P 500 has compounded at a 23% annualized growth rate. That’s a very impressive gain, and it creates the distinct possibility that U.S. equities are now in a secular bull market. But even secular bull markets need a pause now and then, and, after five years, I think that the combination of big gains and slowing earnings growth warrants a rest for the bulls.

Reason 3: China’s economy is slowing

The final reason the market may need a pause is that China’s economy is slowing, as its credit boom finally appears to be reaching its peak. While China may not be systemic to the U.S. market, China has been the marginal growth engine for the world since the global financial crisis in 2008. Therefore, a structural slowdown may provide some modest headwinds for a while.

All in all, my sense is that the market needs a rest. Normally that might mean a double-digit correction, but, within the context of a potential secular bull market, it may just mean a sideways trading range for a few months. After five years of 23% gains, that’s really not such a bad deal.

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Before investing, consider the funds’ investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.
The information presented above reflects the opinions of Jurrien Timmer, director of Global Macro, April 8, 2014. These opinions do not necessarily represent the views of Fidelity or any other person in the Fidelity organization and are subject to change at any time based on market or other conditions. Fidelity disclaims any responsibility to update such views. These views may not be relied on as investment advice and, because investment decisions for a Fidelity fund are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity fund.
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