Global Macro Strategy
A weekly analysis of timely economic strategy issues from Wells Fargo Investment Institute.
Economic Uncertainty’s Impact on Financial Markets
- Slow economic growth, the timing of Federal Reserve (Fed) rate hikes, and the upcoming election likely are contributing to an elevated level of economic uncertainty today.
- Economic-policy uncertainty can feed into investor anxiety about equity markets. It also can influence investor behavior.
What it may mean for investors
- Despite a spike in an economic uncertainty index over recent months, it now has declined. Stock-market volatility also has abated. We believe that periods of economic uncertainty, while uncomfortable, may present opportunities for investors.
Apprehension over economic policy can feed into uncertainties about the stock market. It also can influence investor behavior. When the economic outlook is unclear (due to policy changes or unanticipated events), businesses and consumers often lean toward defensive behavior. Businesses may delay hiring and spending decisions, while consumers might postpone purchases of autos, homes, and appliances. The Economic Policy Uncertainty Index produced by Baker, Bloom, and Davis is designed to measure policy-related economic uncertainty incorporating news coverage, tax-code provisions, and dispersion in economic forecasts. Elevated levels of economic uncertainty typically correspond to slow or declining gross domestic product (GDP) growth, but they also could be related to lack of clarity over monetary policy or upcoming elections. This recovery’s average level of economic uncertainty has been higher than the preceding three recoveries. It has corresponded to a period of slow economic growth and, likely, to questions over the timing of Fed rate hikes.
Despite a large upward spike in economic uncertainty over recent months, the Economic Policy Uncertainty Index has receded while stock-market volatility also has abated. Since the Chicago Board Options Exchange (CBOE) Volatility Index (VIX) spiked above 80 during the financial crisis, the stock market has experienced periodic episodes of increased volatility.1 During the past 12 months, increased volatility has been fueled by concerns over slow global growth, the Fed’s rate-hike timing, and the impact of low oil prices on Energy-sector performance. At the market close on October 17, the VIX stood at 16.
We believe that periods of economic uncertainty, while uncomfortable, may present opportunities for investors. Chart 2 is interesting, not just because the proxy for market anxiety is relatively low, but because it shows the periodic volatility that often is associated with events. Those events typically do not change the path of the U.S. economy’s longer-term growth, and we do not expect that impending events necessarily will derail the recovery this time. Although average economic uncertainty could remain elevated, we see signs of continued labor-market strength, generally strong consumer confidence, and leading economic indicators suggesting that the domestic economy should grow modestly into 2017. As the housing-market outlook improves and as personal income continues to grow, we expect consumers to feel more confident about the economy—potentially leading to additional consumer spending. While apprehension may rise and fall with economic uncertainty and events such as those shown in Chart 2, we believe that U.S. economic growth will continue. Accordingly, we recommend that investors keep a longer-term perspective, remain diversified (to mitigate volatility), and capitalize upon any periods of volatility by adding to targeted positions when markets fall, while trimming positions when markets rise.
1 The CBOE Volatility (VIX) Index measures market expectations of near-term volatility conveyed by S&P 500 Index option prices over a 30-day period. It shows forward-looking market expectation of 30-day volatility and is constructed using implied volatilities of S&P 500 Index options. The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge."
All investing involves risk including the possible loss of principal.
The Economic Policy Uncertainty Index is designed to measure policy-related economic uncertainty, we construct an index from three types of underlying components. One component quantifies newspaper coverage of policy-related economic uncertainty. A second component reflects the number of federal tax code provisions set to expire in future years. The third component uses disagreement among economic forecasters as a proxy for uncertainty.
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