Uncertainty: Does the Stock Market Really Care? | Charles Schwab

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Uncertainty: Does the Stock Market Really Care?

July 10, 2017

“The market hates uncertainty” is an often-repeated stock investing adage. But it didn’t seem to be true during the first half of 2017, when the S&P 500® Index had a total return of 9.34%  despite significant political and monetary policy uncertainty.

Perhaps it just hasn't had an impact yet. Or perhaps there are forces underpinning this bull market that outweigh political turmoil, including strong earnings, steady economic growth, low inflation and still-low interest rates. Let’s take a look at two of the biggest sources of uncertainty.

Political uncertainty

President Donald Trump campaigned on promises of sweeping reform. However, six months past his inauguration, there have been delays in achieving health care reform, tax reform and other perceived pro-growth policies. To date, this has not had a significantly negative impact on stocks.

That may be because analysts generally didn’t take those proposed policies into account when estimating corporate earnings and overall gross domestic product growth for 2017, says Schwab Chief Investment Strategist Liz Ann Sonders. In other words, the expectations bar wasn’t raised.

“The hope around policy did have a positive impact on ‘soft’ economic data, which are survey- and confidence-based measures—they surged post-election but have recently been in retreat,” Liz Ann says. “I continue to believe the spread between the soft and ‘hard’—or actual—economic data will narrow, with the soft data continuing to catch down to the hard data, until we get more clarity on pro-growth policies’ timing, especially tax reform.”

Liz Ann, who in 2005 served on former  President George W. Bush’s nine-member bipartisan tax reform commission— the President’s Advisory Panel on Federal Tax Reform—has observed tax reform efforts up close.

“Let's just say it's not easy,” Liz Ann says. “I believe tax reform would be great for the economy and markets, while tax cuts without true reform would be less good, and tax cuts that sunset—i.e., are temporary—would not be good.”

Federal Reserve policy uncertainty

The Fed is attempting to gently raise short-term interest rates, which dropped to near zero for years after the 2008-2009 financial crisis. At the same time, it is looking to scale back some of the roughly $4.5 trillion of assets currently sitting on its balance sheet. In addition to slashing interest rates in response to the financial crisis, the Fed also bought Treasury and mortgage-backed securities as part of an unprecedented effort to inject more money into a wobbly economy. Shedding some of these securities, either by selling them or simply not replacing bonds as they mature, is part of the Fed’s return of policy to normal.

In theory, tightening monetary policy should slow economic growth, ideally just enough to keep inflation in check without choking off economic growth. Tightening too much or too fast could pose a risk to the economy, which is why investors are keeping a close eye on the Fed’s next moves. Interestingly, since the Fed began raising the federal funds rate in December 2015, financial conditions have actually loosened.

“This is why they are likely to remain on a tightening path, notwithstanding subdued inflation,” Liz Ann says. “But it's also a key reason for the strength in the stock market, which should persist as long as financial conditions don’t tighten too much.”

The bottom line 

Stocks have had a strong run-up during the past eight years or so. Now the bull market may be entering a more mature phase, which could be marked by bouts of volatility and/or pullbacks, Liz Ann says. Earnings growth remains supportive of stocks, but any deterioration in the earnings outlook could spark a market pullback.

However, at present, interest rates remain low, the economy continues to grow and earnings growth remains healthy. Those are the conditions that have supported the bull market for much of its run, and the key things for investors to watch in the second half of 2017.


Important Disclosures 

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

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Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

The S&P 500® Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.

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