Stock investors, after having enjoyed the equivalent of a long and leisurely picnic on a sunny day, are seeing the skies darken and hearing wolves howl in the distant.
“The good news became bad news,” said KC Matthews, chief investment officer at UMB Financial, of a positive jobs report on Friday that showed stronger-than-expected wage gains.
Those wage gains are stoking inflation fears, which contributed to a massive sell-off of stocks Friday and Monday that wiped out all of January’s robust gains in the S&P 500 and Dow Jones industrial average.
But stocks came roaring back Tuesday, with the S&P 500 up 46.2 points, or 1.74 percent, percent to 2,695.14 and the Dow up 567.01, or 2.33 percent, to 24,912.77. The rally eased fears that stocks were tumbling uncontrollably into the jaws of a bear market, defined as a 20 percent or greater decline from the recent peak.
Bear markets are accompanied by recessions, and none of the reliable indicators pointed to an economic reversal, said Matthews, who provided UMB clients with his forecast Tuesday at the Brown Palace Hotel.
“I don’t see a recession on the horizon in 2018,” Matthews said.
He expects the current U.S. recovery, now in the ninth year of an anemic run, to accelerate its pace and enter the record books for longevity.
He is sticking to a forecast made in December that U.S. stock indices will rise 12 percent to 14 percent in 2018 and that the S&P 500 will breach 3,000.
Economic activity is accelerating in Europe and Asia, and the tax cuts Congress passed in December will boost earnings in a big way.
“Tax reform will be a huge benefit for corporate America,” Matthews said.
But the path to those returns won’t be smooth, especially compared to last year. Historically, the second year of the four in a presidential term provides the weakest stock returns.
U.S. stock markets suffer a 5 percent or greater decline every 10 weeks, on average. But before this month, they had gone more than 80 weeks without that kind of adjustment.
He expects volatility will be “front-loaded” or dominant in the first part of the year, with the strongest gains coming after midterm elections clarify the political picture.
But even if the bear doesn’t show, that doesn’t mean wolves aren’t lurking in the forest. One concern that comes with accelerating inflation is that the Federal Reserve will make a misstep, either by taking too strong or too weak a stance to contain an overheating economy.
The turmoil of the past week has pushed up rates on 10-year Treasuries solidly above those of 2-year notes, causing what is known as the yield curve to steepen, said Eric Kelley, director of research at UMB Financial.
“The yield curve is telling you things are strong and getting better,” Kelley said.
A flat or inverted yield curve is normally associated with a recession.
Matthews and Kelley said they continue to favor domestic large cap stocks and are giving international equities more attention. Bonds should be avoided while interest rates are on the rise.
If China’s economy does accelerate, that would push up demand for commodities, making that another asset class to consider investing in. Should inflation gain traction, farmland and timberland have provided a hedge in the past.