Investment Insights: Which weighs more — a black swan or gray rhino?
This weekly report presents insights from our Global Investment Management team.
The stock gauge took a strong first step in 2018, gaining 5.72% in the first month of the year. Bond market returns were less stellar as the yield of the 10-year Treasury rocketed up over 0.30% in January from 2.41% to 2.71%. Cautionary tales seem to have crept their way back into markets, leaving investors wary ahead of prominent earnings reports and a possible shake-up in the healthcare sector from a collaborative effort by Amazon, Berkshire Hathaway, and JPMorgan Chase.
The markets have entered into the heart of earnings season with over a third of S&P 500 companies reporting in the next two weeks including tech giants like Apple, Amazon, and Google. Valuations may have finally become a tangible concern for investors as stocks decline, even as data shows earnings beating estimates by almost 3% and earnings growth of over 11% this quarter, according to data aggregation by Bloomberg. Some of the newly-found pessimism may be from economic data. The consensus expectation by economists for fourth quarter U.S. growth was 3%, but data released by the Bureau of Economic Analysis last week showed 2.6% growth – a fairly notable miss on one of the most important gauges of the economy. Meanwhile, data from Eurostat showed the European Union outpaced U.S. growth in the 2017 calendar year, expanding at 2.5% compared to the 2.3% seen domestically. Trade talks continue to top news headlines as the Trans-Pacific Partnership continues without the U.S., representatives debate crucial corporate arbitration sections of NAFTA, and the recent U.S. tariffs on imported solar panels and washers are rebuked by key trading partners like South Korea and China.
A recent op-ed written by Fan Hengshan, the vice secretary general of the National Development and Reform Commission and the top economic planner in China, outlined potential and substantial tail risks that could occur this year. The editorial states that China’s economic growth may slow to its target of 6.5% this year after growing 6.9% in 2017. Fan wrote that a “black swan” – extremely difficult to predict, high-profile occurrences – and “gray rhino” – obvious, yet ignored threats – are likely to appear in 2018. The Chinese government will be focusing on fending off risks, according to Fan, which may materialize through the curbing of financial risks and cutting debt that had rapidly grown from credit-fueled stimulus.
Our team continues to believe that stock markets will continue their trek upward, but at a considerably more modest pace. The effects of substantial tax cuts should not be ignored and, when combined with the expectation for supportive earnings results, will likely lead markets to new highs even given some worries within valuations. We view the recent pullback as just a bump in the road as markets rebalance and digest news on trade and geopolitics.
Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.
Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.
International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.
Diversification and asset allocation do not ensure a profit or guarantee against loss.