Kristina Hooper is the US investment strategist and head of US Capital Markets Research & Strategy for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
When faced with the stock market’s short-term ups and downs—and the latest geopolitical risks—investors need to filter the noise and focus on fundamentals.
Last week we saw two geopolitical events that threaten to further destabilize conflict-torn regions: A commercial airliner was shot down in Ukraine and Israeli troops invaded Gaza in an effort to stamp out militant group Hamas. Stocks reacted negatively, with prices moving lower and the VIX moving higher, for about a day, before reversing course. The selloff was short-lived likely because data released last week showed an improving macroeconomic backdrop.
Still, Treasuries reflected more fear in the market, with the 10-year Treasury yield finishing below the key 2.5% level. Historically, Treasuries have been a better indicator of fear than the stock market. And stocks have had an unusually strong tilt toward optimism. Some market observers have called it the Bernanke put (and now the Yellen put) given the highly accommodative Fed.
However, the rally in Treasuries may not come as a surprise, given that there are other forces at work, such as a surge in China’s Treasury purchases. Meanwhile, stocks barely flinched on the bad geopolitical news. Stock investors are likely more focused—or at least they should be—on the overall health of the economy, as well as the factors that will most likely impact the Fed’s decision on when to raise short-term interest rates. Last week’s release of the Fed’s Beige Book, an anecdotal report on economic activity, reassured markets that the economy continues to recover.
The turmoil overseas notwithstanding, this week we’ll see a series of important economic data focused on three areas: inflation, housing and manufacturing. Inflation is critical because it has the potential to be the spoiler that forces the Fed to take away the punch bowl sooner than it would like. In other words, if we see a big enough increase in inflation, then it could compel the Fed to raise its target interest rate. The Fed is looking at a mosaic of economic data in determining when to begin raising rates, but inflation is a big piece of that mosaic.
While the Fed views the PCE core price index as the most reliable gauge of inflation, the consumer price index remains an important metric for investors, who have seen prices move higher over the past few months. We expect the CPI to continue to rise, but at a very moderate pace—one that won’t alarm the Fed.
Then there’s housing, which is arguably the weakest part of the economic recovery right now. In her public remarks, including last week’s testimony before Congress, Fed Chair Janet Yellen highlighted concerns over softness in the housing sector.
As a result, we’ll be looking at a spate of housing data this week including the FHFA House Prices Index, existing home sales and new home sales, which should provide a clearer picture of the health of the housing market. Recently, we’ve seen some disappointing data, such as new housing starts and building permits. Nevertheless, we expect the housing recovery to continue—albeit very slowly.
In the manufacturing sector, we’re starting to see signs of a small renaissance in the United States. The Fed’s Beige Book reported that all 12 districts are experiencing stronger manufacturing activity since the previous report. A flurry of data including the PMI manufacturing index, durable goods orders and the Richmond Fed manufacturing index, will give us a sense of whether that revival is gaining momentum.
Looking ahead, this week’s docket for economic data and earnings reports is full. But investors should brace themselves for unfolding geopolitical events that could send stock prices plummeting again. Investors should maintain their discipline by sifting through the noise to focus only on factors that reflect economic conditions and their impact on stock fundamentals or Fed policy.
The bottom line:
Geopolitical crises, even those that have tragic consequences, tend to have little impact on stocks over the longer term.
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