Investors Grapple With Signs of Unrest

Investors are divided over whether the recent stock-market volatility is the start of a larger selloff, but many agree that the optimism that characterized the postelection rally is waning.

The historic calm that enveloped U.S. stocks for much of this year has been upended twice in the past two weeks. The Dow Jones Industrial Average posted its biggest decline in three months on Thursday, one week after a selloff of similar scale sent stock indexes tumbling around the world. Investors are running out of reasons to keep buying U.S. stocks, while at the same time warning signs are accumulating, many investors, traders and analysts have said.

They point to concerns about pockets of the U.S. economy, the Federal Reserve's plan to raise interest rates and unwind its balance sheet, and doubts that corporate earnings can continue to grow at a solid pace.

New worries have emerged: The looming battle in Washington, D.C., over raising the debt ceiling. Rifts within the White House, and President Donald Trump's deteriorating relationship with many business leaders in the wake of the Charlottesville, Va., demonstrations.

Billionaire investor Carl Icahn resigned his position as special adviser to the president on Friday, saying he didn't want "partisan bickering" to cloud the work of the administration. In his resignation letter, Mr. Icahn made no mention of the rallies and violence in Charlottesville.

Such divisions have magnified investors' doubts about the Trump administration's ability to accomplish its agenda, including the tax cuts they had anticipated would boost corporate profits. Those expectations contributed to a stock-market rally that has sent the S&P 500 up 13% since Election Day.

"How the market has behaved since Nov. 9 in many ways seemed like a disconnect from reality," said Kristina Hooper, global market strategist at Invesco. "Investors are starting to recognize that."

Stock declines so far have been short-lived, with many investors viewing them as an opportunity to buy into a market that has been supported by global economic growth and solid corporate earnings.

Nearly 33% of investors surveyed by the American Association of Individual Investors said they expected stock prices to fall over the next six months, the highest level since May. About 34% of investors had a bullish outlook, according to the most recent survey. More than 40% of investors had bullish outlooks for nine consecutive weeks after the election, prior surveys said. AAII polls its roughly 175,000 members weekly, asking them for their take on the whether they expect markets to rise or fall.

U.S. auto sales, an important driver for the broader U.S. economy, fell for the seventh-consecutive month in July, according to Autodata Corp., suggesting a string of sales gains since the financial crisis is plateauing.

Ms. Hooper is concerned about Americans' rising debt levels, which she says in the long term make them more vulnerable to economic shifts, such as a job loss or interest-rate increases. U.S. household debt reached a record last quarter, driven by rising mortgage debt, auto-loan originations and higher credit-card balances, which reached their highest level since 2009.

Some analysts worry about growing debt among consumers because it can suggest people need their credit cards to finance their daily living expenses, while others say credit card debt is a normal part of an economic expansion.

"Two things usually happen before markets get into trouble," said Bruce Bittles, chief investment strategist for Robert W. Baird. "Interest rates go up significantly or consumers spend more."

The Federal Reserve's annual economic symposium in Jackson Hole, Wyo., this week could provide clues about global central bankers' latest thinking. Chairwoman Janet Yellen is scheduled to speak, as well as European Central Bank President Mario Draghi. Several major central banks have signaled their intention to gradually tighten monetary policy, though inflation has remained stubbornly low in places like the U.S. and the eurozone.

The recent selloffs have coincided with some mixed corporate earnings and rising global tensions, including threats between the U.S. and North Korea and terror attacks in Spain.

The Russell 2000, an index of small-capitalization U.S. stocks, and shares of transportation companies have underperformed -- a sign that the broader market could be facing more declines, analysts said. The index is up 0.05% for the year, but is down 6.4% from a high hit in late July. The Dow Jones Transportation Average, a 20-stock index that tracks some of the largest U.S. airlines, railroads and trucking companies, has fallen nearly 6.7% since July 14.

According to stock-market lore, if the transports lag, it can presage broader stock declines, as these companies represent the breadth of the goods shipped across the country and are an indicator of production and consumption.

"We're going to start to see deterioration" in the now eight-year bull market, said Mike Wilson, Morgan Stanley's chief U.S. equity strategist. "Transports not acting particularly good is a very early warning sign that maybe next year may not be as great."

Concerns over lofty valuations have caused some investors to already trim their exposure to U.S. stocks, instead favoring valuation multiples of companies based in Europe.

"The U.S. has been priced for perfection," said Steven Wagner, chief executive of Aventura, Fla., advisory firm Omnia Family Wealth that has moved more of its clients into European stocks from those in the U.S. over the past year. "People are starting to get uncertain and rethink" U.S. stock valuations, he added.

Write to Michael Wursthorn at Michael.Wursthorn@wsj.com and Corrie Driebusch at corrie.driebusch@wsj.com

(END) Dow Jones Newswires

August 20, 2017 10:14 ET (14:14 GMT)