Thinking about why this year’s stock rebound seems to have run out of steam involves coming to grips with why it happened at all.
There are two broad ways to think about asset prices, both perfectly reasonable: driven by sentiment, and driven by fundamentals. Either way, both the selloff at the end of 2018 and the rebound this year were impressively quick.
First, the fundamentals: The fall coincided with worries about the global economy, fear that the U.S. Federal Reserve would tighten monetary policy too much, and concern about steep U.S. tariffs on China. The rebound came after the Fed backtracked, trade talks appeared to be making progress and fears moved from recession to mere slowdown.
Where do we sit now? Of the three issues, the most progress has been made on the Fed, and the least on the economy. Traders in federal-funds futures switched from expecting two to three rate rises this year to thinking there’s a 7% chance of a cut and none at all of a rise, according to CME Group.
Stocks sensitive to the Fed—shares in the utilities and real-estate sectors, known as “bond proxies” for their bondlike behavior—have been the best performers from the end of September, just before the selloff began, helped by Treasury yields having only a desultory bounce from December’s low.
Stocks regarded as least exposed to the economic slowdown did well, too, with consumer staples standing about where they were at the end of September.
Fears about the Chinese economy are hard to disentangle from fears about Chinese trade, but U.S. semiconductor stocks are especially sensitive to tariffs, and rebounded by more than the wider market. The price of copper, more sensitive to Chinese growth than to Sino-U.S. trade, also rebounded to above its September level; like semiconductors, however, it is still hurting from the losses earlier in 2018.
That leaves the global economy. A big rebound this year was justified as concerns about a U.S. recession abated. But the reality is that the global economy isn’t doing very well, with China’s stimulus taking time to kick in, while Europe and Japan struggle with shrinking manufacturing.
Through the lens of sentiment, the world looks a little different. U.S. investors were optimistic before the selloff, turned overly negative by Christmas and then drove stocks back up fast, making further gains difficult.
There’s no science to measuring sentiment, but a self-selecting survey by the American Association of Individual Investors showed that by the end of February, bullishness was almost back up to the level of the start of October, while there was less bearishness. Investors weren’t nearly as exuberant as at the start of last year, when everyone was talking about synchronized global growth. But it looked like the cautious optimism from before the selloff was back. Other sentiment gauges show roughly the same pattern.
Sentiment and fundamentals are tightly linked. Before the market selloff, investors were optimistic. That was punctured by the panic about the Fed, trade and the economy. Markets overcame their worries as the fundamentals improved this year, before investors reached a point where they were no longer too concerned—and it was easier for somewhat worse-than-expected economic news to hit prices.
Today, bulls again outnumber bears, but the optimism isn’t extreme enough to warn of trouble ahead, so investors should focus more on the fundamentals. The Fed is unlikely to be the catalyst; a rate cut at this point would be jarring, likely to prompt fears that the economy is in real trouble. The European Central Bank showed the danger with its slight easing last week. Instead of treating the ECB’s actions as supportive, investors focused on the bad news driving its moves, and stocks fell.
There are still enough fears about trade that a U.S.-China deal would help stocks, especially if it comes with enforcement mechanisms giving it a chance to last. But the talks might still fall apart, dragging markets down once again.
The best gains would come from climbing the final part of last year’s wall of worry by returning to robust economic growth. Unfortunately the economic data have been grim, with the Atlanta Fed’s estimate based on published figures so far putting U.S. annualized growth in the first quarter at just 0.2%. Surveys suggest factory output is shrinking in China, Japan and the eurozone.
With a dingy outlook for growth, and prices most of the way back up to last year’s highs, U.S. stocks don’t look especially appealing. But there’s no sign of investors returning to the recession fears that would justify another big selloff, either. No wonder stocks are drifting.
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