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Market Insights: A market in transition

Key Highlights

 

With early February reminding investors that volatility is never too far removed from financial markets, we may have entered a period of transition in financial markets in which swings are likely to be more common occurrences. This should not have been entirely unexpected as markets have been moving in a fairly static pattern for a long time (see Exhibit 1) and this shift may well be part of the return to a level of normalcy. In assessing the current economic picture, it may be helpful to think of the landscape through the lens of an economic scorecard, with both positives and negatives (see Exhibit 2).

Exhibit 1

Exhibit 2

 

The positive side

Consider the left side of the scorecard. First, despite a significant market correction, a recovery soon followed the market sell-off in early February, with roughly two-thirds of value being restored in the ensuing weeks. 1 Both domestic and international equities have rebounded nicely with the S&P 500 Index and MSCI EAFE Index returning 1.83% and 0.30%, respectively, year to date.2 Synchronized global growth has continued to provide support for the markets. Second, corporate earnings have been strong and industry estimates suggest this may continue to be a driver for the U.S. economy (see Exhibit 3). Third, GDP growth has been strong with the fourth quarter of last year registering an estimated 2.5%.3 Finally, the U.S. unemployment rate is at its lowest level in decades which is positive news for wage growth and spending (see Exhibit 4).

Exhibit 3

Exhibit 4

1 Source: Bloomberg, 2/28/18.
2 Source: Bloomberg, 2/28/18.
3 Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2/28/18.

 

The negative side of the scorecard

Turning to the other side of the scorecard, we believe there are five items that investors should monitor as the year unfolds. First, for some time, market participants and the Fed had been concerned about the potential of deflation in the U.S. economy. With inflation starting to creep up in economic data, the focus has shifted from deflation to inflation which has created uncertainty in the market. Second, the Fed has now hinted, most recently via Chair Powell’s testimony to Congress, that it may hike interest rates four times this year, instead of three, given the strong growth prospects of the economy and the threat of higher inflation. Third, trade protectionism, with President Trump introducing steel and aluminum tariffs, is now on the rise. Fourth, interest rates increased as we started the new year, although they then leveled off and actually have fallen recently (see Exhibit 5). Finally, largely due to the GOP tax cuts, the federal deficit has ballooned, with a commensurate tripling in the amount of U.S. Treasury debt that the market must absorb compared to fiscal year 2017.

 

Exhibit 5

 

What does it all mean?

The negatives may appear greater than the positives but that does not necessarily mean there is cause to be alarmed about the market in the near term. While greater caution is warranted, we believe solid corporate earnings should offset the “negatives”. Although markets have entered a period of transition, bringing increased volatility, we think that this could be symptomatic of the shift to more normal financial markets rather than the end of the bull market.

 

Glossary
The Standard & Poor’s 500 Index (S&P 500) is a capitalization-weighted index of 500 stocks. The Index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The MSCI EAFE (Europe, Australia, Far East) Index is recognized as the preeminent benchmark in the U.S. to measure international equity performance. It comprises 21 MSCI country indexes, representing the developed markets outside of North America. Returns are in U.S. dollars.

Price/earnings (P/E) is the price of a stock divided by its earnings per share. Sometimes called the multiple, P/E gives investors an idea of how much they are paying for a company’s earning power. The higher the P/E, the more investors are paying, and therefore the more earnings growth they are expecting.

 

These views represent the opinions of the Chief Investment Officer and are not intended as investment advice or to predict or depict the performance of any investment. These views are as of the close of business on March 2, 2018, based on the information available at the time and are subject to change at any time based on market or other conditions. We disclaim any responsibility to update such views. All investing involves risk, including possible loss of principal. Equities are subject to market risk (the risk that the entire stock market will decline because of an event such as deterioration in the economy or a rise in interest rates), as well as special risks associated with investing in certain types of stocks, such as small-cap, global and international stocks. International investing may be volatile and involve additional expenses and special risks including currency fluctuations, foreign taxes and geopolitical risks. Emerging and developing markets may be especially volatile. Fixed income investing includes interest rate risk and credit risk. Interest rate risk is the risk that bonds will decrease in value as interest rates rise. As a general rule, longer-term bonds fluctuate more than shorter-term bonds in reaction to changes in interest rates.
Credit risk is the risk that bonds will decline in value as the result of a decline in the credit rating of the bonds or the economy as a whole, or that the issuer will be unable to pay interest and/or principal when due. Investors cannot directly invest in any index. There are also special risks associated with investing in certain types of bonds, including liquidity risk and prepayment and extension risk, or investing in high yield (junk) bonds. There are additional risks associated with the use of derivatives. Past performance does not guarantee future results.

First Investors Funds are managed by Foresters Investment Management Company, Inc. underwritten and distributed by Foresters Financial Services, Inc.; each is a wholly owned subsidiary of Foresters Financial Holding Company, Inc. (FFHC).
Foresters Financial™ and Foresters™ are the trade names and trademarks of The Independent Order of Foresters, a fraternal benefit society, 789 Don Mills Road, Toronto, Canada M3C 1T9 and its subsidiaries, including FFHC.

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