The second quarter and first half of 2018 came to an end last Friday, and the S&P 500 posted a 2.93 percent gain for the three month period and was 1.67 percent higher so far in 2018.
As the weekly chart highlights, the S&P 500 index rallied steadily, with a few speed bumps, from February 2016 through late January 2018. Since the start of the second month of this year, price variance in stocks increased dramatically.
There are currently bullish and bearish factors pulling stocks in two directions and fueling increased volatility in the equities market. On the bullish side, tax reform and economic growth in the United States has been highly supportive of corporate earnings which is a primary driver of share prices in the stock market. At the same time, investor optimism remains near recent highs causing capital to flow into the equities market.
Meanwhile, stocks corrected lower in February under the weight of rising interest rates. Economic growth combined with the decline in the Federal Reserve’s balance sheet as they continue to allow the legacy of quantitative easing to roll off on a monthly basis has put pressure on bond prices. On the short end of the yield curve, the Fed added another rate hike to their agenda at their June meeting meaning that the Fed Funds rate will rise to 2.25-2.250 percent by the end of 2018. Stocks compete with fixed income securities for capital flows, and higher rates have weighed on the prices of many shares causing an increase in two-way volatility in the S&P 500 index and other equity indices.
Moreover, the current trade issues that are facing markets have caused concerns that U.S. corporate profits could begin to suffer when it comes to tariffs on other products from trading partners around the world and retaliation on U.S. products exported abroad. In an attempt to fulfill promises made on the campaign trail to level the playing field in international trade and create an environment of “reciprocity and fairness” the world now faces a tense period where the potential of a trade war has increased.
The U.S. has slapped tariffs on steel and aluminum from Canada, Mexico, the European Union as well as other countries around the world. On July 6, the first tariffs that will total at least $50 billion on China will take effect. Those countries impacted by the protectionist measures have retaliated against the U.S. causing an increase in volatility in markets across all asset classes.
Economic growth and optimism are bullish for stocks, but higher rates and a wave of protectionism are not. The bullish and bearish strings pulling at equities these days could be a prescription for lots of volatility in the coming days, weeks, and months. While volatility is a nightmare for investors, it is a paradise for nimble traders as it increases the number of short-term opportunities on both the long and short side of the market. So long as equities find themselves in an environment where the path of least resistance for prices is not all that clear, trading rather than investing is likely to be the optimal approach to the stock market.