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Stocks Aren’t Spooky, but Expect More Volatility: Schwab

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It may be the spookiest time of year (Happy Halloween!) but stocks aren’t so spooky, according to the latest market perspective from Charles Schwab’s Liz Ann Sonders, Jeffrey Kleintop and Brad Sorensen.

According to the commentary, most measures of investor sentiment have moved firmly into optimistic territory. However, behavioral measures of sentiment don’t yet match that optimism.

Sonders, Kleintop and Sorensen note that flows into domestic equity mutual funds and exchange-traded funds continue to be flat-to-negative on a cumulative basis.

“The recent lack of volatility and ‘Teflon’ nature of the stock market has boosted investor optimism but may have also bred complacency about ongoing risks,” the trio writes. “We expect more upticks in volatility.”

Sonders, Kleintop and Sorensen believe the bull market will continue and suggest investors remain at their target allocations.

“We believe the current bull market will ultimately be followed by a traditional bear market — at a point of either excess tightening by the Federal Reserve and/or the anticipation of an economic recession,” they write. “Neither is in our sights, although there are enough risks that a pullback could occur with even a minor catalyst.”

Potential causes for an uptick in volatility could include the pick of the next Fed chair (an announcement could come as soon as Thursday, The New York Times reported), tax reform, as well as geopolitical and trade issues.

The nomination of the next Fed chair (and possibly vice chair) “could have implications for short-term market volatility, but none of the candidates to this point are likely to make a kneejerk direction change [to] monetary policy,” according to the commentary. 

Regarding tax reform, the trio say they have been inundated lately by questions about the prospects for tax reform and the implications for stocks. 

“While the lack of a deal would likely be disappointing, we don’t believe economists or analysts have yet built the expectation for tax reform into forward-looking estimates; so the effect is likely to be more psychological than numerical,” they write.

Looking globally, there is currently a strong earnings outlook. The trio points to data from FactSet reporting that earnings per share growth for the year ending in the third quarter was up 17% from a year ago for companies in the MSCI World index reporting through Oct. 25.

“The strong earnings outlook is important to where stocks are headed; but other developments may affect global markets in the weeks ahead, including: post-vote European economic data, the announcement by the European Central Bank to taper asset purchases next year, and North American Free Trade Agreement (NAFTA) negotiations,” the trio writes.

All of this – global and domestic growth, along with a solid earnings picture and a potential tax reform tailwind – suggest investors should remain at their target equity allocations, according to Sonders, Kleintop and Sorensen. 

They note that while pullbacks are possible, a recession doesn’t appear to be “in the cards in the near term.”

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