By Anora M. Gaudiano, MarketWatch
'Seasoned investors will be watching for retests of the lows':
Prudential's Krosby
The U.S. stock market on Friday posted one of its best weekly
performances in years, recapturing half of the losses from the
startling market correction earlier this month and discovering a
new "wall of worry" to climb.
The S&P 500 closed nearly flat at 2,732. 22 on Friday and
booked a 4.3% weekly gain, and is now only 5% below the all-time
peak set in January. Dow industrials also halved its peak-to-trough
losses, while both indexes are up about 2% year to date.
The latest six-day advance was only briefly interrupted Friday
by the indictment of 13 Russian citizens for allegedly interfering
in the 2016 U.S. election
(http://www.marketwatch.com/story/13-russians-charged-with-interfering-in-us-elections-2018-02-16).
Investors will have a chance to reflect on the performance over
a three-day weekend, with U.S. financial markets closed
(http://www.marketwatch.com/story/which-markets-are-closed-on-presidents-day-2018-02-14)on
Monday in observance of the Presidents Day holiday.
Erin Browne, head of asset allocation at UBS in a note to
clients said the recent selloff that sent markets into their first
10% correction in two years had been primarily driven by technicals
rather than fundamentals.
See:Here's the nagging question at the heart of the stock-market
selloff
(http://www.marketwatch.com/story/heres-the-nagging-question-at-the-heart-of-the-stock-market-selloff-2018-02-12)
"Events over the past few weeks serve as a salutary reminder of
both the dangers of crowded positions and of the power of technical
forces when combined with consensual positioning," Browne said.
"Importantly, we do not believe that the very strong global
growth and earnings backdrop has suddenly evaporated," she
said.
Indeed, the fourth-quarter earnings season has been quite
remarkable. According to John Butters, senior earnings analyst at
FactSet, out of around 400 S&P 500 companies who have reported
results, 75% beat on profits and 78% beat sales estimates.
Whether the stock market fully regains confidence in earnings
and the economy will become clear in the next few weeks.
So far, a V-shaped recovery is taking hold, matching the speed
of the decline, though investors aren't quite out of the woods yet,
according to Quincy Krosby, chief market strategist at Prudential
Financial.
"Seasoned investors will be watching for the retests of the
lows. For now, we just added a new wall of worry to climb and that
is inflation," said Krosby.
The wall of worry is a term used to describe the stock market's
tendency to overcome potentially negative factors as it climbs.
It's a contrarian concept in that investors fear stocks can stall
once the concerns making up the wall of worry have been
dispatched.
Interestingly, fears of rising inflation and higher borrowing
costs--whether rational or irrational--were blamed for triggering
the stock market selloff in the first place.
See:The stock market and the bond market have struck a truce
(http://www.marketwatch.com/story/the-stock-market-and-the-bond-market-have-struck-a-truce-2018-02-16)
"We are no longer in the Goldilocks environment, when bad news
was good news. Now, the good news is seen as bad news. The market
is trying to figure out whether the growth in earnings will keep up
with the pace of inflation," Krosby said.
Investors have reasons to fear inflation, even though it has
remained subdued for a long time. Even the latest data show that
inflation is still below trend and the Federal Reserve's target of
2%.
Higher inflation and subsequent higher borrowing costs can
destabilize companies and households with high debt levels.
Unwinding of highly leveraged portfolios would almost certainly hit
risky assets such as stocks or junk bonds.
But even if stocks post positive returns amid heightened
volatility, higher inflation (whether driven by solid economic
growth or not) would reduce real returns or both stocks and
bonds.
What has changed in the big picture is how the Fed operates in
an environment of rising inflation and rising interest rates,
Krosby said.
"We're in a situation where the Fed is actively trying to reduce
their balance sheet by selling bonds at the same time when the
government will need to borrow more than a trillion dollars to
finance the deficit. Yields will have to go higher," Krosby
said.
"Markets will be fine with higher yields and higher inflation as
long as the economy is solidly expanding and companies are able to
pass on the price hikes onto the consumers," Krosby said.
Next week, investors will be able to get some clues about the
Federal Reserve's thinking from the minutes of the January policy
meeting, the last chaired by Janet Yellen.
The new chairman, Jerome Powell, in remarks during his
swearing-in ceremony
(http://www.marketwatch.com/story/powell-says-fed-will-remain-alert-to-any-financial-stability-risks-2018-02-13)
on Feb. 13 suggested that the Fed will push ahead with scheduled
rate increases. Meanwhile, other policy makers played down market
volatility.
Apart from Fed minutes due on Wednesday at 2 p.m. Eastern, the
calendar is light on economic news. Flash PMI and existing home
sales figures are due on Wednesday and weekly jobless claims are
due on Thursday.
Several Fed officials are also scheduled to speak. Philadelphia
Federal Reserve Bank President Patrick Harker and Minneapolis
Federal Reserve Bank President Neel Kashkari are scheduled to speak
on Wednesday. New York Federal Reserve Bank President William
Dudley is slated to speak on Thursday, while Cleveland Federal
Reserve Bank President Loretta Mester and San Francisco Federal
Reserve Bank President John Williams have speaking engagements on
Friday.
(END) Dow Jones Newswires
February 19, 2018 03:49 ET (08:49 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.