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More Market Drama May Be on Its Way: Schwab

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The bull market should continue to run, but expect a little more drama, according to Schwab’s Liz Ann Sonders, Jeffrey Kleintop and Brad Sorensen.

In the trio’s latest market perspective, they address several reasons why this may be expected.

First up is an anticipated melt-up. “U.S. stock market gains have accelerated in the first month of the year, leading to the appearance of a melt-up or blow-off phase of the bull market,” according to the report.

The report notes that melt-ups can last for “a decent amount of time” — so investors who bail could miss out on potential gains.

While this move is still in its relatively early stages, it could be a catalyst for a pullback at any time.

And, according to the report, more frequent pullbacks and volatility could be seen this year.

“With optimism elevated and valuations rich, the cushion in the market has been reduced—which could lead to more volatility and more sizable pullbacks this year than we saw last year,” the report states.

According to the report, some of the potential risks to the current rally may come from Washington.

While the market has largely ignored the “shutdown” drama, the report wants that investors should not become complacent about the risk of political dysfunction.

“Trade protectionism — including possibly pulling out of NAFTA — and tariffs could be a meaningful risk for stocks, especially if they contribute to higher inflation,” the report states, also noting that the midterm elections could add to the market’s volatility.

The most formidable risk in the report’s view is higher inflation, which is why the statement from the Federal Reserve’s upcoming meeting is worth a watch.

“The statement will be closely watched for signs that inflation is becoming a bigger concern due to the tight labor market and tax-related fiscal stimulus,” the report states. “Higher inflation remains the most formidable risk in our view, as it would put added pressure on the Fed and downward pressure on stock market valuations.”

Another area that could bring tension to the markets are the risks to the Euroboom.

According to the report, there are near-term risks that are worth watching overseas, like the upcoming Italian election and euro currency strength.

The report notes that markets are not pricing in much risk from the Italian election, which means they may be vulnerable to a surprise if populist parties perform better than expected. 

Meanwhile, the report also notes that the euro relative to the U.S. dollar is up from about 1.07 a year ago to about 1.24, a rise of 16% with about half of that coming in just the past two months.

“The impact of a sharply rising currency may be starting to negatively impact growth in the eurozone,” according to the report.

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