There was little reason to believe that 2017’s near-zero levels of volatility were sustainable.
- From January 1, 2010 to December 31, 2016:
- 12.3% of trading days were up more than +1.0%
- 10.6% of trading days were down more than -1.0%
- By comparison, 2017 was almost entirely without meaningful volatility:
- 1.6% of trading days were up more than +1.0%
- 1.6% of trading days were down more than -1.0%i
- If recent gyrations feel particularly unsettling or unexpected, just remember that 2017’s long stretch of low volatility and high returns was actually the anomaly.
In recent correspondence, we discussed drivers of lower-than-average volatility over the last few years. Namely, “quantitative easing” programs were synthetically feeding liquidity into the capital markets, and much of that liquidity undoubtedly supported higher equity prices.
Now, with the Federal Reserve reversing many of those programs and on course for tighter monetary policy, the stage is set for a return to normal market volatility. Inflation pressures, fears of rising interest rates, and the threat of a “trade war” are just examples of how potential negatives can lead to market gyrations in this environment. That being said, we do not believe any of these negatives—together or alone—currently has the power to derail the economic expansion.
Trade fears have largely driven the volatility narrative, but it should be noted that nearly all of the administration’s trade initiatives so far have been watered down as the process played out.
Case in point: in early March, President Trump imposed a steel tariff of 25% and an aluminum tariff of 10%, but within a few days, Canada, Mexico, the EU, Argentina, Australia, South Korea, and Brazil had all been exempted. What started as a material negative was narrowed in scope significantly.
China’s response was to levy a tariff on select US imports (pork, recycled aluminum, wine, nuts, etc.) worth about $3 billion. is seemed substantial at the time, but in reality it only equates to a tariff on 0.00136% of total US exports and 0.00015% of US GDP. In a word: insignificant.
All of the other tariff announcements to date—$50 billion on about 1,300 Chinese-made products, $50 billion on American products like soybeans, planes, cars and beef, and $100 billion undisclosed tariffs on Chinese goods—have not been implemented. ey are merely proposed tariffs and are now subject to a public comment period that lasts until May 22iv. We expect the administration to receive substantial pressure from industry groups and corporate lobbies, many of which are from states that voted for Trump in 2016. is pressure, in our view, is likely to result in a much milder outcome to the trade dispute than many expect.
In our view, a bearish stance in the current environment would mean overestimating the potentially harmful effects of a trade war while underestimating the robust outlook for corporate earnings, positive global economic growth trends, and the positive effects of the fiscal stimulus and regulatory easing. Even the fiscal stimulus alone dwarfs the estimated size of tariffs:
Meanwhile, Corporate America is arguably on its firmest footing in nearly a decade. S&P 500 earnings are expected to expand by +17.3% in Q1 and +18.5% for full-year 2018, on +6.7% higher revenues. In a typical quarter, analysts generally decrease their earnings estimates once they get a clearer picture of the numbers. During the past fifteen years (60 quarters), analysts have decreased EPS estimates by an average of -4.1% during a quarter. The chart below shows how Q1 bucked the trend completely.
The combination of double-digit expected earnings growth and recent market volatility has compressed S&P 500 P/E multiples, which now sit at their lowest level since early 2016vi. Stocks are arguably more attractive today than they were at the beginning of the year.
Market bumpiness may persist, and it may be unsettling. But we believe it will not overwhelm the positive fundamentals that we see driving stocks higher over the course of the year. If anything, volatility can provide us with strategic opportunities for rebalancing and/or entering new positions at more attractive valuations.
If you have any questions or would like to discuss any of these matters further, please do not hesitate to reach out directly.