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Kristina Hooper | March 20, 2018

Revolving headlines lead to a tug of war for stocks

Across the globe, stocks experienced a tug of war last week, with good news (positive earnings and other signs of accelerating growth) and bad news (concerns that protectionist actions could slow economic growth) influencing the markets. I believe this tug of war will very likely continue going forward, and I’ll be closely watching for more market-moving news this week as new central bank leaders make their debuts.

Key events from last week

Chinese retail sales improve. As I mentioned last week, Chinese retail sales for January and February would be important to follow as China had shown signs of a modest slowdown in the fourth quarter. Fortunately, retail sales data for January and February actually improved over December, although they remained lackluster relative to the growth recorded in the past year. We will want to follow this closely, as one or two data points are obviously not enough to discern a trend.

Eurozone industrial production disappoints. Eurozone industrial production for January was released last week, showing a fall of 1% for the month.1 This was well below expectations and contradicted the narrative, at least briefly, that the eurozone economy is accelerating. Less of a surprise was the February consumer price inflation reading, which showed lower inflation (the lowest reading in more than a year) and supported the European Central Bank’s (ECB) view that they see no signs of an uptrend in inflation. Both data points suggest there is no pressure on the ECB to become less accommodative with monetary policy.

U.S. inflation remains subdued – for now. A number of important U.S. inflation readings were also released last week. The core consumer price index for February indicated subdued inflation, as did the producer price index for the same month. This news came on the heels of a more moderate average hourly earnings reading from the February jobs report. The one surprise in inflation reports last week was the Atlanta Fed’s Inflation Expectations Index. February’s reading showed a small increase in year-ahead inflation expectations. While expectations for inflation are still somewhat subdued, I believe the increase shows that companies are concerned about a rise in prices – be they rising input prices (which could potentially be caused by tariffs) or rising wages (which some industries and regions are experiencing, as reported in the most recent Fed Beige Book). My expectation is that inflation will increase this year, albeit moderately.

Bitcoin loses steam. Bitcoin continued to come under pressure last week as the U.S. government seemed closer to regulating cryptocurrency exchanges. This comes as Japan is more heavily regulating these exchanges, which also added to pressure. I also believe that another force may be driving down the price of bitcoin – the VIX. Last year, when bitcoin rose dramatically in price, the VIX was low and speculative investors may have turned to bitcoin for the “rush” of rapid price changes that were largely unavailable in the stock market at that time. Now that we are experiencing the ups and downs of a “Chihuahua market” and the VIX has risen significantly, stocks – and even bonds – may be offering enough of a “rush” to speculative investors that they are eschewing investments in cryptocurrencies. Expect more volatility for bitcoin in the coming week as cryptocurrencies are on the agenda for the G20 finance ministers’ meeting.

What to watch this week

A new leader at the Fed. March is shaping up to be a month of transitions for monetary policy. The biggest transition is, of course, the new Federal Open Market Committee (FOMC). Not only is there a new Federal Reserve (Fed) chair presiding over his first meeting this week, but there are also new voting members on the FOMC. To many observers, it is a foregone conclusion that the Fed will raise rates at this meeting. The press conference and dot plot will be critical to follow as we get to know Chair Jay Powell and his FOMC. Keep in mind that markets have been relying on the last dot plot – released back in December – which reflects the policy prescriptions of the former chair’s FOMC. The dot plot released this week will reflect the policy prescriptions of this new FOMC and it could offer significant differences, especially as more recent economic readings suggest higher inflation. We will also want to see if, in the press conference, Powell suggests the possibility of diverting from the balance sheet normalization plan put in place by former Fed Chair Janet Yellen last year. While this is not my base case, the potential that this new FOMC accelerates balance sheet normalization is certainly a significant risk.

A new leader for China’s central bank. The Fed is not the only central bank undergoing a transition. The People’s Bank of China reportedly has a new leader, Yi Gang, a well-respected economist who served as the second-in-command under the previous governor, Zhou Xiaochaun. While he is new to the role, he is expected to provide policy continuity, having served more than a decade under his predecessor. However, he joins at a critical time for China as it attempts to orchestrate broad reforms at the same time it avoids a “hard landing” for its economy.

Other events to follow this week include:

  • The Bank of England’s meeting, where it is expected to keep rates at current levels and maintain its asset purchase program. However, we will want to pay close attention to wording in the announcement for clues about future moves
  • Negotiations in the U.S. Congress regarding a bill to continue funding the government. Funding for the current U.S. government runs out on Friday and, while Congress has largely arrived at an agreement, it is still working out some significant, politically polarizing line items of spending that have the potential to derail this bill
  • The potential for more talk on tariffs, particularly as the U.S. is expected to focus on China as a target of protectionist policies. Trade concerns are likely to flare up at the meeting of G20 finance ministers this week. Also, the European Union is expected to announce a tariff on digital revenues this week

Looking ahead, it’s important to keep in mind that, as rates rise and both positive and negative data are released, equity and fixed income markets are likely to gyrate. Asset class, capitalization and style leadership are likely to rotate multiple times over the course of the year. While many investors seem to have increased their risk appetite in recent days, it is important for them to maintain the discipline of broad diversification. Over time, broad diversification – especially the inclusion of alternative, lower-correlating asset classes – may be very helpful in achieving long-term goals with less volatility. I believe that is particularly so given the current market environment.

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1 Source: Eurostat, as of March 14, 2018

Diversification does not guarantee a profit or eliminate the risk of loss.

Alternative products typically hold more non-traditional investments and employ more complex trading strategies, including hedging and leveraging through derivatives, short selling and opportunistic strategies that change with market conditions. Investors considering alternatives should be aware of their unique characteristics and additional risks from the strategies they use. Like all investments, performance will fluctuate. You can lose money.

The producer price index (PPI) is compiled by the U.S. Bureau of Labor Statistics and measures the average change over time in the selling prices received by domestic producers for their output.
The consumer price index (CPI) measures change in consumer prices. Core CPI excludes the food and energy sectors.

The Federal Reserve Bank of Atlanta’s Business Inflation Expectations Survey was created to measure the year-ahead inflationary sentiments of businesses in the Sixth District. About 300 panelists receive the survey each month, and represent businesses of various sizes headquartered within the Sixth District, which encompasses Alabama, Florida, Georgia, and sections of Louisiana, Mississippi and Tennessee. Survey responses are weighted by industry shares of national gross domestic product.

The Summary of Commentary on Current Economic Conditions by Federal Reserve District (commonly known as the Beige Book) is published eight times per year. Each Federal Reserve Bank gathers anecdotal information on current economic conditions in its district, and the Beige Book summarizes this information by district and sector.

Cryptocurrencies are digital currencies that use cryptography for security and are not controlled by a central authority, such as a central bank.

Bitcoin are considered a highly speculative investment due to their lack of guaranteed value and limited track record. Because of their digital nature, they pose risk from hackers, malware, fraud, and operational glitches. Bitcoin are not legal tender and are operated by a decentralized authority, unlike government-issued currencies. Bitcoin exchanges and Bitcoin accounts are not backed or insured by any type of federal or government program or bank.

The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility.

Important information

All investing involves risk, including risk of loss.
The opinions referenced above are those of Kristina Hooper as of March 19, 2018. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.

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