Markets & Economy

Market Resets for a Higher Growth World

Market Resets for a Higher Growth World
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In our view, the recent equity market sell-off does not reflect a change in the fundamental outlook. We believe the global economy is strong, with little sign of a looming recession or other fundamental dislocations.

  • Economic growth, corporate fundamentals, and earnings growth remain strong and are improving. The market is instead reacting to a world with expectations of higher inflation and higher interest rates.
  • The market was priced for a Goldilocks environment of modest global growth and low inflation and is now adjusting to a potential new reality.
  • We believe we are now in a higher-growth world, and with that comes expectations for higher wages, higher inflation and higher interest rates.

Chart 1

Last week we saw the first evidence of inflation pressures with U.S. wage growth the highest in nine years. The market took notice and the equity and bond markets sold off.

We believe that the market is resetting itself for a new world where growth, inflation and rates move higher. What had become unsustainable was a continuation in the velocity of upward price action accompanied by unusually low volatility and investor complacency, particularly as an entire generation of investors had become accustomed to near-zero rates for nearly a decade.

Chart 2

We believe rates globally are moving up, and this will compress P/E ratios. Right now, earnings growth expectations for 2018 are very strong at 18%, and earnings are expected to come in at $156.5 for the S&P500. Nevertheless, the expectations for higher rates will likely work on market multiples and could remain a headwind to equity prices despite our constructive outlook.

Chart 3

Credit spreads have widened somewhat, but remain at low levels relative to history. At this point, there are not many signs of contagion to this asset class and, therefore, it is still premature to forecast a larger credit stress.

We believe the duration and severity of this correction should be limited thanks to strong economic and corporate fundamentals that are unchanged despite the recent downtrend in stock prices.

RISKS

All investments involve risk including loss of principal. Certain investments involve greater or unique risks that should be considered along with the objectives, fees, and expenses before investing. Equities are subject to market, market sector, market liquidity, issuer, and investment style risks to varying degrees. Bonds are subject to interest rate, credit, liquidity, call and market risks, to varying degrees. Generally, all other factors being equal, bond prices are inversely related to interest-rate changes and rate increases can cause price declines. Investing in foreign denominated and/or domiciled securities involves special risks, including changes in currency exchange rates, political, economic, and social instability, limited company information, differing auditing and legal standards, and less market liquidity. These risks generally are greater with emerging market countries.

The price-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings. The priceearnings ratio is also sometimes known as the price multiple or the earnings multiple.

The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. The S&P 500 is one of the most commonly used benchmarks for the overall U.S. stock market, and is an index that tracks the performance of the largest 500 U.S. companies. It is not possible to invest directly in an unmanaged index.

Views expressed are those of the advisor stated and do not reflect views of other managers or the firm overall. Views are current as of the date of this publication and subject to change. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular investment, strategy, investment manager or account arrangement. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Please consult a legal, tax or investment advisor in order to determine whether an investment product or service is appropriate for a particular situation. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. The Dreyfus Corporation and MBSC Securities Corporation are companies of BNY Mellon. © 2018 MBSC Securities Corporation, 225 Liberty Street, 19th Floor, New York, NY 10281.

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