What’s Driving the Market’s Volatility?

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Volatility has returned to the stock market in a big way over the last few weeks. I'm here with Bob Johnson--he's our director of economic analysis--for his take on why he thinks this volatility is happening and if investors should be worried. Bob. thanks for joining me.

Bob Johnson: It's good to be here today.

Glaser: Let's start by looking at that volatility. It's often chalked up to these amorphous global-growth fears. Do you buy that? Is the data really what's driving this volatility?

Johnson: I think it's certainly part of it. And certainly, the world market is beginning to slow a little bit. And especially in Europe, where you've seen the economic data get a little worse every day--and just when you think it can't get any worse, we get a little bit more bad data. And what's happened is, sometimes, that bad news overseas is viewed as good news because it means more quantitative easing, low interest rates forever, and people get very excited about that.

Then the next day, people have to come back and think, "Oh, wait, but that means earnings might be lower, too. And maybe the dollar is stronger; that means less sales overseas." So, all of a sudden, yesterday's bad news is bad news. They seem to be rotating back and forth on that. And certainly, as rates have continued to come in here, people are asking, "Well, what else am I going to invest in?"

So, they go back and buy stocks. Then the next day, they think, "Maybe earnings won't be so good." And then they sell them the next day. So, we've seen this type of volatility. Now, there are a few other things behind the volatility. Certainly, August, September, and October are not great months relative to volatility; there are some seasonal issues that happen every year about when certain things get funded. There is tax-law selling that begins to occur. There are a number of things that make this a particularly volatile time of year anyway, and we're just seeing a little bit more of that than usual.

Certainly, the energy stocks: Again, some people look at the energy news and say, "Wow, falling oil prices isn’t that great. It's great for the consumer." I'm generally in that camp. On the other hand, energy stocks are not an insignificant part of the stock market, and so as those stocks come in, we get some volatility from that as well. Certainly, there is a question of the stronger dollar and what that does to earnings overseas and as it translates back to the U.S. So, while a lot of things that I am saying might be good news for the U.S., they might not be as good for multinational corporations.

Glaser: If the news out of Europe is the driver of that bad news, then what about economic data out of the U.S.? We had retail sales that didn’t look so great. That data came out this week.

Johnson: Let's talk about the retail sales number: It was the key disappointing number this week. Certainly, at a 0.3% decline, it looked relatively meaningful; but that wasn’t that far off expectations. What got people worried is even when you stripped out autos, which we all knew was going to be a bad number and gasoline, which is primarily related to the lower price--not lower usage--if you strip those out, we were still down in terms of retail sales. Only 0.1%, but nevertheless we were down.

But the retail sales numbers are volatile from month to month; the seasonal factors are particularly screwed up, and these numbers get restated a lot. When you look at the data in a more sensitive way, on a year-over-year moving average basis and adjust for inflation, the average has been about 1.9% over the last 12 months and we're at 2.4% right now, after we've gotten the number for September. So, that's not so bad. I'm not really scared. This number is volatile from month to month, but it happened the catch the market on a day when everybody's saying, "Europe's falling apart, and now the U.S. is falling apart. And if the U.S. starts falling apart, then the rest of the world's got no place to sell to and we're all in a bunch of trouble."

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Glaser: But even if this number isn't quite as bad as the headline shows, U.S. consumers still aren't doing great. There is still a lot of hesitance to spend. What do you think is holding back the U.S. consumer?

Johnson: I think you are very right to point that out. Incomes are up a lot. One would suspect the lower energy prices, the higher incomes, the better employment data would all roll into a picture where the consumer should be spending probably a lot more. And now, they are just kind of at the high end of average in terms of their spending situation. Why is that? Certainly, housing is stalled out for a variety of reasons, and a lot of things go for furniture and a lot of things kind of trail through that whole cycle. Certainly, that’s been a weak market.

Certainly, the news about ISIS and Ebola all over the headlines hasn't done wonders to build consumer confidence, and that's probably weighed a little bit. Then, we've also got the situation where the high-earning part of the economy--who have a lot of money in stocks--they are now a little bit scared. And we've been positing all of this stuff about income inequality and people who have a choice don’t have to spend money; maybe now that their stock portfolios are down, in some cases up to 10%, they may be saying, "I'm going to be a little bit cautious in my spending." Or maybe the money gets spent a month or two later than they originally thought. But in any case, certainly, that's not helping matters. Then, over the summer, the food-price surge didn’t help on the low end of the market when we saw record increases in the price of beef. So, if you roll all that together, there are some reasons why [consumer spending is] a little bit soft.

Glaser: So, with this somewhat unsettling volatility and some of this bad news, are you worried at all about the U.S. economy? Or do you think that your projections of steady GDP growth remain the same?

Johnson: In terms of the U.S. economy, I am still relatively bullish. I don’t think any of the news this week or last week, frankly, changes my mind very much at all. I look at the data and it's usually a bad bout of inflation or where we've got a bunch of dislocations in the economy where we are short of capacity. None of those things are going on--none of those preconditions for recession are really there. It just appears to be normal volatility and, certainly, we came from a high level of valuation--and maybe that's all that's going on here. So, I'm not worried, in fact even in the retail sales numbers. Spending at restaurants is up 0.6%. If consumers were really scared, would they be going out to eat as much as they are? This is usually one of my better indicators. It certainly indicates to me that they are not running scared.

Glaser: But are you more afraid about Europe?

Johnson: I am a little bit more worried about two things. One is Europe; I think they certainly haven't figured out how to get their economy growing again, and that's a worry. And you've got some countries that have tax-policy issues; you've got other countries that have corruption issues and other countries that really need to stimulate a little internal growth. There are just too many things that need to be done that aren't getting done, and I'm afraid they could waffle here with not much growth and maybe even wander into recession at any time in Europe.

So, I am indeed worried about Europe. I'm also worried on the corporate side on earnings. Europe is not an insignificant part of people's earnings outlooks for multinational corporations, and maybe as much as 40% of S&P revenues come from overseas markets. So, it's a pretty significant number. As those things slow, even though the U.S. economy and workers will do fine, corporate profits maybe not so much.

Glaser: Bob, I certainly appreciate your take on volatility today.

Johnson: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.