Key Points

  • The move above 20k by the Dow wasn't the catalyst some hoped it would be, and the sideways movement in equities continues. Investor caution is rising, which contrarily should help the bull market continue.
  • Economic data has continued to beat expectations, but the number of upside surprises may start to level off, and investor enthusiasm toward potential new policies from Washington could wane as political realities set in.
  • International growth appears stable, but acceleration doesn’t seem to be on the horizon, while trade tensions pose a risk to global economies and markets.

Running with chains

Since the Dow finally breached the 20k mark, equities have been largely range-bound. The enthusiasm seen in measures of investor sentiment following the election of Donald Trump has waned a bit as the realities of policy priorities—and getting things done in Washington—begin to set in. Both the Ned Davis Research (NDR) Daily Trading Sentiment Composite and the AAII (American Association of Individual Investors) bull-bear ratio have pulled back from overly optimistic territory, which should be a positive development for the continuation of the bull market.

Subdued volatility, but…

Subdued volatility

Source: FactSet, Chicago Board Options Exchange. As of Feb. 9, 2017.

Much ink has been spilled about the extremely low level of equity market volatility—with the volatility index (VIX) remaining near record lows. This suggests heightened investor complacency; but it also masks a notable development in the market’s internal behavior. Correlations among U.S. equity sectors have plunged according to ISI Research, which means that certain sectors doing well have been largely offset by other sectors doing poorly; thus there's been a "cancelling out" effect which has contributed to today's low volatility. Interestingly we appear to have moved from this cycle's earlier "risk on, risk off" mode (when correlations were high) to perhaps "Trump on, Trump off" mode (with correlations having plunged).

Politics has been a dominant force behind both market behavior and confidence measures. A market, an industry or a company, which can be moved by a single tweet, is a new twist. And investors aren’t the only ones paying attention. The Wall Street Journal recently reported that of the 242 companies that held conference calls or other investor events in January, half of them mentioned President Trump; with most of them expressing continued cautious optimism toward the potential for new growth-oriented policies. There is little doubt that there have been some bumps in the initial stages of the new administration but there's also little question that this White House has gotten more done in the first few weeks of a term than any other in recent memory. However, that breakneck pace has multiple speed bumps put in by the Constitution, which means that tax reform and some of the more complicated regulatory reforms will likely take longer than investors and companies had hoped. This—as well as the historical tendency for weak Februarys in new administrations (according to Strategas Research Partners)—could lead to some pullbacks in the market. But at this point we view these as potential buying opportunities as we remain bullish on U.S. equities. Patience is likely to be a virtue.

Economic improvements may slow

As we've often preached, the direction and relative strength of economic data tends to matter more than the level or absolute strength. As seen in the chart below, the trough in relative economic data occurred in October 2016, arguably at least as relevant to the rally as the presidential election. Remember, the Citi Economic Surprise Index measures how data is coming in relative to economists' expectations.

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