One Man’s Opinion: Will US Equities Pull Back If The Euro Is Threatened?

Stock market text reflecting in man's eyeglasses

From a fundamental backdrop, the outlook for the US economy seems relatively constructive in terms of the macro environment, while from a policy perspective, the Federal Reserve is unlikely to do anything that’s going to undermine the notion that it has been a very cautious, pragmatic deliberate approach by the US central bank, said Mike Ryan, chief investment strategist at UBS.

So, from the fundamental side, it seems the economic environment is okay though the gains are likely to be pretty measured. There has been a pretty big re-rating in the equity markets; the earnings momentum has slowed a bit although the first quarter result was probably a bit exaggerated, and investors are likely to witness mid-single digit gains.

It may not be the replay of the seasonal theme “sell in May and go away,” but it’s going to be an environment where investors are going to see more choppy markets and more limited gains, probably through at least the summer, he noted.

Asked if volatility is going to subside in the summer months, since the Fed has ruled out a rate hike in June, Mike answered in negative. There are other things that add to market volatility; Greece will start negotiations in June and there are other events that are likely to happen in the summer, including ongoing global geopolitical events.

So, there are lots of other issues beyond the Fed that could add to market volatility. In an environment where investors typically witness less liquid conditions, those types of factors can get exaggerated. It’s unlikely that investors are going to see an incredibly choppy market; rather it could be a less directional move where investors are likely to see equity markets moving uniform higher, he observed.

The Fed is unlikely to act this summer, and the central bank is likely to make a move sometime between September and December, though the probability of December is much higher, said Anthony Chan, chief economist at Chase.

The equity market tends to show elevated volatility when the Federal Reserve typically starts to think about raising rates. However, when looked at volatility over long periods of time, higher volatility means it spooks investors and the stock market goes down. But if the VIX is considered, it actually shows the 30-day expected “volatility” while other gauges show expected volatility over the next three months and one-year respectively. If volatility over the last few years is considered, it clearly shows the trend is going from negative to positive; which means that since the central banks are coddling the markets, investors not only witness many mini corrections ranging from more than 3 percent and less than 10 percent, they have also grown less fearful about corrections. Historically, volatility is bad for the equity markets, but for the last few years, volatility has not been very severe, he explained.

The last major pullback had taken place between April and October 2011 when the S&P 500 index had shed nearly 20 percent. But the average pullback witnessed since then hovered around only 5 percent, meaning investors step in before any deep correction and buy in the overall market.

Asked if investors should start buying every time markets correct around five percent, because that has been the trend over the past four-five years, Tony said whenever the markets fell sharply over the past four-five years, the central bank immediately issued statements to assuage investors’ fears of an imminent rate hike.

Data shows that since 1940, bull markets typically witnessed 19 mini corrections before running out of steam whereas the US equity markets have witnessed 50 mini corrections since the Bull Run started in 2009. That clearly shows the central banks are coddling the markets and are stepping in whenever there’s a sharp drop, he argued.

Each time there has been a correction in the past four-five years, investors need to ask two questions; why and at what level, Mike said. Each time in the past four-five years investors re-entered markets typically at lower valuation levels, which means valuations look pretty expensive now.

Back in 2011, there were pretty chunky tail-risk issues like a possible Greece exit from the eurozone. So if scenarios like whether the euro-zone will hold together resurface again, along with the impending political drama that involves US elections next year, there could be bigger corrections than the modest pullbacks witnessed on earlier occasions.

You can watch the video here.

 

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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