Advertiser Disclosure

Stock Market Outlook: A Market That Giveth and Taketh Away

The market topics du jour — the yield curve, inflation and trade spats — are likely to bring more volatility in July. But that could actually be good for stock investors.
July 3, 2018
Investing, Investing Data, Investing Strategy, Investments

There’s no refuge from the daily news lately, especially when it comes to the stock market.

What the market giveth to investors one day, it can taketh away the next. On June 25, for example, the S&P 500 had its biggest drop in weeks after President Donald Trump tweeted about new threats against U.S. trade partners. In one day, the market nearly erased its month-to-date gains.

Summertime on Wall Street tends to be quieter, with less trading volume as traders and investors take vacations, but that dynamic can magnify daily moves. This type of market choppiness, known as volatility, has become more common this year. The S&P 500 has risen or fallen in excess of 1% on nearly 29% of trading days, compared with a historical average of about 21% of trading days.

And the topics du jour right now — the yield curve, inflation and talk of tariffs — are likely to lead to more volatility in the month ahead, says Ann Miletti, a managing director and lead portfolio manager at Wells Fargo Asset Management.

“Volatility isn’t necessarily a bad thing; it can bring opportunity,” Miletti says. “But you can’t let the volatility cause you to make emotional moves.”

» Ready to start investing in stocks? Follow our simple, four-step guide.

With these dynamics at play, July’s not likely to give professional investors reason to ignore the news, even during a month that’s historically delivered the biggest average gains, at 1.5%, according to data compiled by Yardeni Research. Here’s what investors will be watching.

Interest rates command interest

Stock market investors haven’t been able to ignore what’s happening in the bond market this year — and for good reason. Right now, one of the most watched charts on Wall Street is commanding the attention of investors of all varieties.

The so-called yield curve, which plots the difference between interest rates on short-term U.S. government bonds versus long-term bonds, is flashing warning signals to investors, with the difference between two-year Treasury yields and 10-year Treasury yields narrowing lately.

When the yield curve inverts, that’s not a good sign for stocks usually.

Ernie Cecilia, chief investment officer at Bryn Mawr Trust

The concern is the yield curve could invert, meaning the yield on long-term Treasuries is lower than that of short-term Treasuries. An inverted yield curve has preceded every U.S. recession in the past 60 years, according to research from the Federal Reserve Bank of San Francisco.

While the yield curve could stay in its relatively flattened state for some time, professional investors worry about the implications if it doesn’t. “When the yield curve inverts, that’s not a good sign for stocks usually,” says Ernie Cecilia, chief investment officer at Bryn Mawr Trust, a financial services company in Bryn Mawr, Pennsylvania.

More broadly, investors are focused on interest rates and the Federal Reserve’s next steps. At its meeting in June, policymakers signaled it may raise rates two more times this year — for a total of four hikes — and that took some investors by surprise, Cecilia says.

» Fed rate hikes: Here’s what to do when rates rise

While the reason central bankers are doing so is positive — economic growth is robust enough to support higher rates — “the risk is if the Fed raises rates too quickly, it could stunt economic growth and the bull market in stocks,” he says.

What to do: What’s happening with the yield curve and interest rates bears watching, but there’s no need to overhaul your portfolio, Cecilia says. Rather, take this opportunity to ensure you’re well-diversified, both among asset classes (like stocks and bonds) and within each. Consider allocating more to small-cap stocks, which are more insulated from potential trade spats and have outperformed large-cap stocks this year, Cecilia says. Within bonds, he recommends those with shorter-duration maturities.

All eyes on earnings

Mid-July will mark the return of earnings season, when publicly traded companies report revenue and profits for the second quarter that ends June 30. Analysts forecast that companies in the S&P 500 will report the second-highest growth in earnings in seven years, behind the first quarter of this year, according to data compiled by FactSet.

Earnings season is never about what companies are reporting but what they say the outlook is.

Ann Miletti, managing director and lead portfolio manager at Wells Fargo Asset Management

Why do earnings matter so much? Earnings season gives investors an opportunity to see how companies fared in terms of revenue growth and profitability — and, as importantly, what their expectations are for the future, Miletti says. Earnings season isn’t “necessarily the trigger to invest,” but rather a time for gathering data, she adds.

Miletti says she will focus on three things when analyzing quarterly reports:

  1. How revenue and earnings growth compare with the first quarter.
  2. The outlook and expectations shared by management teams for the forthcoming quarter.
  3. Confidence among corporate management — as evidenced by whether they’re willing to invest more money in their companies.

“What most investors should realize is that earnings season is never about what companies are reporting but what they say the outlook is,” Miletti says. “News headlines can get dragged down by a lot of negativity, but I’m seeing some very positive signs when I’m looking at companies” — and that should support “generally positive” second-quarter earnings, she adds.

That said, Miletti will monitor one possible area of concern — inflation — and whether companies can pass along higher prices to customers. Even before the suggestion of new tariffs arose, some companies were reporting higher costs of raw materials (like steel and timber) or services, she says.

What to do: Earnings season offers investors an opportunity to better understand the dynamics affecting stocks in their portfolios — or ones they’re considering buying. Want to dive in? Listen to recordings (available through a company’s investor relations portal) or find transcripts online of the conference calls companies host to discuss earnings. The sections where managers field questions can be especially informative, Miletti says.

Stock market forecast

While this year is proving to be more typical, in terms of both market volatility and year-to-date returns, that may be of little assurance if you’re questioning how much longer the current bull market will persist. But if you’re invested for the long haul, don’t try to time swings in the market or stress about the events of one day, one week or even one month.

As for the outlook ahead, the news of recent weeks has done little to rattle investors on Wall Street. Strategists are forecasting the S&P 500 will end the year above 2,900 — nearly 9% higher than its current level — according to the average forecast of strategists surveyed by CNBC. Even so, investors off Wall Street are more cautious. The percentage of consumers who expect stock prices will fall in the next six months hit the highest level in two months in late June, according to a weekly sentiment survey by the American Association of Individual Investors.

The news of recent weeks has done little to rattle investors on and off Wall Street.

Buying when stock prices are fluctuating can be intimidating, so focus on the facts instead: Stocks have proven to be a fantastic long-term investment.

The market undoubtedly will go up and down in the course of your investing timeline. One way to minimize the risk of a big shock to your portfolio is to ensure you spread money across a variety of assets and develop a discipline of investing regularly. If diversification in your portfolio is lacking, consider beefing up your exposure to international stocks, for example.

Finally, long-term investors can be opportunistic and take advantage of market dips. Dollar-cost averaging, which involves regularly adding money to your investments to help smooth out your purchase price, ensures you won’t dump all your money in when stock prices are at a peak.

About the author