Stocks slip and slide
Stocks resumed their slide last week with the major indexes all suffering significant losses. The carnage was particularly bad for U.S. technology stocks, with the Nasdaq Composite Index losing 5.41% to end the week at 4,363. The S&P 500 Index fell 3.09% to 1,880 and the Dow Jones Industrial Average was down 1.59% to 16,204. The selloff in riskier assets extended to bonds. The difference between the yield of corporate bonds and Treasuries of comparable maturity widened as investors sold the riskier corporates. High yield bonds once again experienced the largest losses as investors flocked into safe-haven assets, which included gold as well as Treasuries. Flows into both were positive on the week. The yield on the benchmark 10-year U.S. Treasury fell from 1.92% to 1.83% as its price rose.
Investors may have grown weary of the bleak midwinter volatility, but unfortunately, spring is still a long way off. The elements are in place for continued volatility, and the comfort of central bank accommodation is not as reliable as it once was. But investors still have options available that can help provide at least some degree of insulation for their portfolios.
Economic weakness and revised Fed expectations
The recent weakness in stocks can be attributed to several factors. To start, we saw further volatility in energy markets. However, investors were more focused on further evidence of economic deceleration in the United States. Last week brought poor ISM manufacturing and services surveys, although a rebound in new orders did offer one glimmer of hope. On the labor front, job growth remains strong but appears to have crested as employers are faced with difficulty finding qualified workers and uncertainty over financial market conditions.
Ironically, however, another problem for stocks is coming from rising wages. Higher wages are ultimately a positive for the consumer, but they put pressure on companies’ margins. In January, hourly wages were up 0.5%. If rising wages are not accompanied by faster productivity, profit margins will come under pressure.
Finally, a weaker dollar added to the pressure on international stocks. The dollar rebounded on Friday, but is still down more than 3% from its December peak. Investors are selling the dollar as expectations for U.S. growth and Federal Reserve (Fed) tightening continue to fade. Consensus forecasts for 2016 economic growth have fallen from 2.7% in early October to 2.4% today, and with that downgrade, investors are even less convinced that the Fed will hike rates four times this year, as it had implied. Investors place the odds of a March hike at 10% today––down from 50% at the start of January.
Meanwhile, the euro rallied, hitting a four-month high of 1.12 versus the dollar. With the euro strengthening, investors are questioning whether additional monetary stimulus by the European Central Bank (ECB) will have its intended effect. This concern is reinforced by the fact that, thus far, the introduction of quantitative easing (QE) in Europe has not been able to lift equities there. Since the ECB’s QE program began a little over a year ago, European equities are down and earnings estimates have fallen. If the euro remains resilient due to a more dovish path by the Fed, QE may be less effective in lifting European asset prices.
Ironically, the one market that proved resilient last week was China, with A-Shares traded in Shenzhen gaining more than 3%. Equities benefited from a further injection of liquidity by the central bank as well as some minor strengthening in the local currency. However, on the economic front, the picture remains broadly the same: weak manufacturing while the services sector continues to grow.