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Focus on Fundamentals, Not Geopolitical Crises 

Kristina Hooper 

The Upshot 


Crises have flared up dramatically in the Gaza Strip and Ukraine, but the real story for stock investors is the pace of economic expansion and how it impacts the Fed’s decision making, writes Kristina Hooper.

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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.

Temporary Jitters

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.

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.”

Big Data

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.”
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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Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. It is not possible to invest directly in an index.

The Consumer Price Index (CPI) is an unmanaged index representing the rate of inflation of the U.S. consumer prices as determined by the U.S. Department of Labor Statistics. There can be no guarantee that the CPI or other indexes will reflect the exact level of inflation at any given time.

The Standard & Poor’s 500 Composite Index (S&P 500) is an unmanaged index that is generally representative of the U.S. stock market.

The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility.

The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.

A Word About Risk
: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.


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