Week Ahead: Volatility To Continue Driving Markets? Oil, USD Lower?

The S&P 500 Index rebounded from a 1.06 percent opening loss on Friday, to a 0.5 percent gain in the final hour of the session. The rally was led by Healthcare (+1 percent), followed closely by Technology (+0.95 percent). The only three sectors in the red were Real Estate (-0.33 percent), Utilities (-0.26 percent) and Materials (0.1 percent).

The advance trimmed the benchmark index's weekly decline to 2 percent. On a weekly basis, all sectors were in the red, led by Materials (-3.8 percent) and Industrials (-3.28 percent). 'Outperformers' were Technology (-0.89 percent) and Consumer Staples (-1.12 percent). Both leaders and laggards included defensive as well as growth stocks, perhaps demonstrating the lack of leadership in the current market move.

Last week, as February ended, equities were mired in their first monthly loss since October 2016, the final month before the US election, when the so-called Trump trade began.

The Dow Jones Industrial Average rebounded on Friday from an opening 1.55 percent drop, trimming losses in the final hour, though it still closed down 0.3 percent. That put the mega-cap index lower by 3 percent for the week.

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The NASDAQ Composite bounced from a 1.3 percent opening slide to a jump in the final hour that helped it end 1.1 percent higher, paring its weekly loss to just 1.05 percent.

The Russell 2000 went through the same lower open and higher final hour. However, as we have been consistently pointing out, the small-cap benchmark continuously bucks the trend, positively and negatively. After opening 1 percent lower, it closed 1.6 percent higher, outperforming the bigger cap indices.

The market narrative that drove the initial drop and final-hour rebound began with fear about the negative aspects of the Trump trade agenda, according to investors. Toward the end of the session, however, the idea that what the president says will not necessarily follow through to action, allowed investors to reinvest into growth assets.

This characterization of the president’s rhetoric would be naturally interpreted differently by critics. It supports his base voters' view that he talks a big game but he’s a negotiator, someone who starts with a strong position but is open to compromise.

We expect that investors will go back and forth on this issue, ranging from whether it will follow through into action to whether it would hurt stock prices, even if it continues to do so, at least in the short term.

We have seen this merry-go-round of market narratives in the last weeks with regard to higher interest rates. After yields initially spiked to 4-year highs, investors dumped stocks more aggressively than they had in two years, gripped by fear of a faster path than anticipated to higher interest rates.

That was followed by the biggest accumulation in 18 months—even as yields remained at 4-year highs—suggesting that investors had overcome their initial fears of rates hurting growth and stock prices and perhaps were now focusing on the positive aspects of an improving economy, such as a nurturing environment for company growth and higher stock prices.

However, stocks tumbled again on Tuesday when Federal Reserve Chair Jerome Powell testified before the House Financial Services Committee that he and the rest of the central bank's policymakers were “going to be taking the developments since the December Meeting into account and writing down our new rate paths.” Nonetheless, both the recent inflation surge, as well as the 4-year high yields already provided the signal. Still, perhaps hearing it straight from the Fed chief unnerved investors enough to sell off, as if they were hearing about this new outlook to higher rates for the first time.

No matter one's chosen narrative, the most important development in the stock market right now—and the current biggest driver—is the return of volatility.