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Low Volatility Could Mean ‘More Extreme’ Stock Pullback: Schwab’s Aguilar

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Fueled by favorable unemployment numbers and positive corporate earnings, U.S. stocks have continued to trend higher. But how long will it last?

“I would be surprised if we do not see a pullback,” Omar Aguilar, chief investment officer of equities and multi-asset strategies at Charles Schwab Investment Management, told ThinkAdvisor. “I think the market has run up too quickly, too fast. It is healthy for the market to get some sort of small correction.”

According to Aguilar, a small correction and higher volatility in the market is “something that is expected.” However, he warned that a potential pullback could be more extreme if volatility doesn’t pick up.

“Despite the uncertainty coming from the political landscape in the United States, we haven’t seen volatility pick up,” Aguilar told ThinkAdvisor. “We have been in these [low levels of volatility] that is a little bit counterintuitive because you would think with everything that’s going on in a daily basis that volatility would have spiked up. And we haven’t seen it.”

And, as Aguilar often tells Schwab clients, a lack of volatility doesn’t necessarily mean there is no risk.

“In fact, the more quiet the market is, the more chances that the pullback may be more extreme and aggressive,” Aguilar said.

For right now, though, expectations for corporate tax reform and infrastructure spending continue to fuel “animal spirits” and investor confidence, driving up stocks.

“We still see optimism in the market,” Aguilar told ThinkAdvisor. “That started after the U.S. election. The big rally is still there. So the market’s still up for the year and still a continuation of the same trends we saw last year.”

According to Aguilar, this investor optimism largely comes from expectations that the new administration will deliver on fiscal stimulus, infrastructure spending and deregulation — all leading to future economic growth.

“The market obviously felt fairly optimistic after the results of the election and the prospects for future economic growth,” he said. “The new administration is pro-growth. It is fueling the idea that we will need to grow faster and that we will find the ways to invest in the country to make sure that that happens.”

At the same time, according to Aguilar, the probability of disappointment seems to have increased with every point added by the Dow.

The challenge is that in order for investor optimism to be persistent, investors need to start seeing data that supports the pro-growth agenda.

“Folks are starting to get a little more anxious about the gap between expectations and real data — which is natural and expected because the rally was fairly quick,” Aguilar told ThinkAdvisor.

That real data includes GDP growth, earnings growth, consumer spending, capital expenditures for corporations and future earnings — “It’s going to take a while for us to see those,” Aguilar said.

Meanwhile, he said, people are starting to feel uncertain about how quickly the new administration can deliver on its promises.

“The chances that either the fiscal stimulus will not come as fast as everybody expected — obviously that’s a risk to the market — and the probability that the widening of the deficit that is required for infrastructure spending is not approved by Congress is still a probability of disappointment,” Aguilar said. “And the actual impact of the deregulation is something that is still hard to measure.”

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