The market bloodshed that spilled into this week, with a 2.6% loss for the Standard & Poor’s 500, should subside due to a number of market forces that will counteract the bad news—fear of escalating interest rates.
That’s the view from UBS Securities’ strategists, who figure the current market drop should be around 5%. When economic data is so positive, falls tend to be shallow, they wrote in a report. In their view, “When economic data surprises have been positive, equity pullbacks have averaged 5%, suggesting last week’s 4% sell-off is close to an end.” When economic data is discouraging, they added, a dip is more like 9%.
Some of the evidence that buoys them:
Valuation adjustment. Many have lamented that the market was getting over-priced, as seen by the price/earnings multiple. The drop in market prices, plus expected earnings expansion from the federal tax cuts, have lowered the S&P 500’s forward P/E to 17.6, from its 18.5 peak in January.
Dividends, buybacks and M&A. Expected higher earnings will bear fruit with a torrent of dividend income channeled to investors—and the UBS strategists put that at $60 billion going into their accounts near-term. Better, that begins this week. Thanks to corporate cash brought back from overseas, courtesy of the tax law change, buybacks of stocks should hit a record of $550 billion in 2018, they estimated. In addition, mergers are picking up the pace lately. These all put upward pressure on stock prices.
Bond spreads. The gaps between corporate bonds and risk-free Treasuries remains tight, signaling that investors see no cause for alarm. If they did, the spreads would be wider. Right now, investment grade paper’s spread is around 1 percentage point (it was 2 in 2016). High-yield bonds have just a 3-point spread (down from almost 8 two years ago).
Single-stock trading volume. This is the turf of small investors, who typically get spooked the most. Their trading during this sell-off is muted compared to during previous market scares, such as the mid-2016 Brexit vote. So “this suggests a firmer mindset among equity investors,” UBS wrote.
Fear gauge. The volatility index, or VIX (also known as the fear gauge), is up lately from its previous single-digit level, which showed how placid the market has been as it soared. When the VIX spikes, that betokens trouble. But the index has risen to just 17, which is short of its average, 19.
Thus, UBS contended, much of the hand-wringing about the market is unwarranted.