Stock Market Volatility Isn’t the Big Problem. This Is.

By Ben Levisohn

People at a shopping mall in New York City./ Spencer Platt/Getty Images

Markets lived up to their reputation for periodic craziness this past week. 

But it’s the economic volatility that has the potential to do the most damage.

The S&P 500 index fell 1.4%, while the Dow Jones Industrial Average dropped 1.1%, and the Nasdaq Composite was off 2.3%. 

That might look bad, but it was far worse at Wednesday’s close, with each index down more than 3% on the week after the consumer-price index rose 0.8% in April from March—more than quadruple expectations for a 0.2% rise.

The jump in inflation—and the gap between it and expectations—was similar to April’s payrolls, which came in at just 266,000, well below forecasts for 975,000, the biggest miss on record. 

Making matters worse, few would have predicted either the inflation or employment data given the previous readings: March’s CPI had risen 0.5%, just 0.1% higher than expectations, while payrolls had come in at 916,000, beating the consensus by 261,000. 

“There is unprecedented volatility in the numbers,” says Deutsche Bank strategist Alan Ruskin. 

“In a normal stable environment, a big miss is 50,000.”

The stock market is supposed to be volatile. 

The U.S. economy? 

Not so much. 

But that’s exactly what’s been happening since the pandemic hit. 

One way to measure economic volatility is to look at changes in personal-consumption expenditures, says Evercore ISI strategist Dennis DeBusschere. 

Normally, the variation in readings is fairly small, with the volatility of the measure never more than one standard deviation above or below the average since 1990. 

It’s now 5.5 standard deviations above its average, DeBusschere says, which never happened even during the depths of the financial crisis.

With variability like that, it’s hard to predict the future. 

That makes life difficult for Federal Reserve Chairman Jerome Powell and the Fed governors, who can’t look into a crystal ball and decide whether they should stick to their guns about inflation being transitory or modify their views, which don’t call for the first rate hike until 2024. 

How the Fed answers that question could decide if the market experiences even more volatility than it saw this past week.

Up to now, the Treasury market has been anything but volatile. 

Yes, the 10-year note ended the week with a 1.635% yield, higher than the prior week, but still range-bound. 

The ICE BofAML MOVE index, which tracks the implied volatility of the Treasury options market, has barely budged. 

Don’t expect it to stay that way if the Fed starts tapering its bond purchases. 

The volatility could ripple through bonds and into other financial markets.

Still, more volatility doesn’t mean that stocks are headed for a bear market, even if there are corrections along the way. 

The reason: Global earnings are expected to grow at a 36% clip this year, an astounding rate, but not one that is uncommon for this stage of a bull market, says Citigroup equity strategist Robert Buckland .

The stock market typically has a very good year when earnings are growing by 25% or more; the MSCI All World index posted positive returns in 2010 and 2004. 

If history repeats, 2021 should turn out OK—even if investors need to start worrying about 2022, when earnings growth starts to slow. 

“This year, earnings are enough to get us through,” Buckland says.

That’s true even for the highflying growth stocks that have been getting hit so hard recently—as long as they have earnings. 

Adam Parker, founder of Trivariate Research, notes that following large growth selloffs, S&P 500 growth stocks with both free cash flow and expanding margins tend to outperform in the months ahead. 

That means favoring stocks like ServiceNow (ticker: NOW) and Advanced Micro Devices (AMD) over shares of Chegg (CHGG) and Twitter (TWTR). 

“Buy some growth stocks on the selloff, but they have to have positive free cash flow and margin expansion,” Parker says.

Or you could be in for more than just a little volatility.

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