The U.S. and global equity markets plunged in early February, with market participants concerned about a number of factors. What’s driving the turbulence, and is it likely to continue?

The year began with a pronounced disconnect between economic growth (both realized and expected) and the bond market. The disconnect could not persist indefinitely.

Continued strong economic growth, however, suggests that current bond-market repricing and multiple compression in equities are nearing completion.

Bond Market

It is likely that we are nearing the end of the current correction in the bond market.

The bond market has been repricing growth. Long-term yields on U.S. bonds are up to 2.82% (and have been as high as 2.88%), some 30 basis points greater than they were in early January. There are no signs of trouble in the bond markets, no widening of corporate spreads—not even in high yield.

Because a 10-year yield of below 3.00% would be consistent with current growth and the near-term outlook, it is likely that we are nearing the end of the current correction in the bond market. In my opinion, it will last perhaps one to two more weeks, if that.

Inflation

With growth now firm around the world, the market’s attention has turned to signs of inflation. In a nutshell, I believe it is premature to worry about a meaningful acceleration in inflation from current levels.

In Europe, the expansion is still in early stages. For example, from peak to trough, Italy has lost 9% of gross domestic product (GDP) since the global financial crisis. So far, it has recovered only about 3.5%, so the output gap is still meaningful.

Spain, having grown by more than 3% for several years now only returned to pre-crisis GDP levels late last year. With the exception of Germany, every country in Europe is somewhere between Italy and Spain.

All labor-market reforms that have been introduced over the past several years (including 2017 in France) mean that the employment/inflation tradeoff is much more favorable now compared to a few years ago. That means Europe can grow for longer and employment growth can continue for longer from current levels before we see widespread wage pressures.

While the weak U.S. dollar points to some upward pressure on consumer prices, the United States is a fairly closed economy, so the pass-through is likely to be minimal.

In the United States, the expansion is much more advanced. Hence, the talk of inflation is louder. At the same time, prices have remained benign. Hourly earnings growth has not yet accelerated meaningfully despite continued strong employment gains, and consumer price inflation is not showing signs of acceleration.

While the weak U.S. dollar points to some upward pressure on consumer prices, the United States is a fairly closed economy, so the pass-through is likely to be minimal.

U.S. Dollar

The most surprising aspect of the unfolding correction has been the depreciation of the U.S. dollar. One reason is that larger U.S. current-account deficits mean more U.S. dollars flowing abroad. This improves U.S. dollar liquidity, but also depreciates the currency.

At the same time, U.S. Treasury issuance is expected to double from 2017 levels this year, and a larger fiscal deficit means more financing needs at a time when growth differentials make the United States marginally less attractive.

We are likely to see a return to earnings trends and other fundamentals driving returns.

A Return to Fundamentals?

Continued strong economic growth suggests that current bond-market repricing and multiple compression in equities are nearing completion. So, in my opinion, we are likely to see a return to earnings trends and other fundamentals driving returns.

 

RELATED POSTS

SUBSCRIBE NOW

Gain insights on macro market events, the economy, and investing strategies.
Receive our latest blog posts in your Inbox with headlines like:

SIGN UP

FOLLOW US

twitterfooterlinkedinfooteryoutubefooterfacebookfooter

RSS FEED

Please carefully consider the Funds’ investment objective, risks, charges, and expenses before investing. This and other information is contained in the Funds’ prospectus, which you may obtain by calling +1 800 742 7272. Read it carefully before you invest or send money. Investing includes the risk of loss.

Any statements or opinions expressed are those of the author as of the date of publication, are subject to change without notice as economic and markets conditions dictate, and may not reflect the opinions of other investment teams within William Blair Investment Management, LLC or the Investment Management Division of William Blair & Company, L.L.C.

This content is for informational and educational purposes only and not intended as investment advice or a recommendation to buy or sell any security. Investment advice and recommendations can be provided only after careful consideration of an investor’s objectives, guidelines, and restrictions.

Factual information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Investments are subject to market risk. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Statements concerning financial market trends are based on current market conditions, which will fluctuate.

William Blair does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax questions and concerns.

Distributed by William Blair & Company, L.L.C., member FINRA/SIPC.

Copyright © 2018 William Blair & Company, L.L.C. "William Blair” is a registered trademark of William Blair & Company, L.L.C. No part of this material may be reproduced in any form, or referred to in any other publication, without express written consent.

Statement of Financial Condition | NMS Rule 605 & 606 | Business Continuity Plan | UK Stewardship Code
Cookie Policy | Social Media Disclaimer | Privacy & Security | FINRA’s BrokerCheck

FOLLOW US

twitterfooterlinkedinfooteryoutubefooterfacebookfooter

RSS FEED

Please carefully consider the Funds’ investment objective, risks, charges, and expenses before investing. This and other information is contained in the Funds’ prospectus, which you may obtain by calling +1 800 742 7272. Read it carefully before you invest or send money. Investing includes the risk of loss.

Any statements or opinions expressed are those of the author as of the date of publication, are subject to change without notice as economic and markets conditions dictate, and may not reflect the opinions of other investment teams within William Blair Investment Management, LLC or the Investment Management Division of William Blair & Company, L.L.C.

This content is for informational and educational purposes only and not intended as investment advice or a recommendation to buy or sell any security. Investment advice and recommendations can be provided only after careful consideration of an investor’s objectives, guidelines, and restrictions.

Factual information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Investments are subject to market risk. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Statements concerning financial market trends are based on current market conditions, which will fluctuate.

William Blair does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax questions and concerns.

Distributed by William Blair & Company, L.L.C., member FINRA/SIPC.

Copyright © 2018 William Blair & Company, L.L.C. "William Blair” is a registered trademark of William Blair & Company, L.L.C. No part of this material may be reproduced in any form, or referred to in any other publication, without express written consent.

Statement of Financial Condition | NMS Rule 605 & 606 | Business Continuity Plan | UK Stewardship Code
Cookie Policy | Social Media Disclaimer | Privacy & Security | FINRA’s BrokerCheck

Subscribe Now

Gain insights on macro market events, the economy, and investing strategies. Receive our latest blog posts in your Inbox with headlines like:

SIGN UP

Send this to friend