Mark Twain famously wrote that October “is one of the most peculiarly dangerous months for stocks.” The others, Twain noted, are July, January, September, April, November, May, December, June, March, February, and August. With Twain’s quote acknowledged, October 2018 seems to be contradicting his tongue-in-cheek premise.
The ghosts of October continued to rain downside volatility Wednesday. Stocks experienced a sharp and widespread selloff with the Dow Jones Industrial Average declining 2.4%, the S&P 500® falling 3.1%, and the NASDAQ dropping 4.4%. It was a strange day to say the least, as a host of events combined to wreak havoc on an already skittish market. These included:
Disturbing threats in the political world. News broke early in the day regarding the targeting of a number of political leaders in the Democratic Party as well as media outlet CNN with mail bombs that fortunately were intercepted by authorities before any harm occurred. Barack Obama, Bill and Hillary Clinton, and potentially others were targeted, as more confirmations are still pending. Coming less than two weeks before the midterm congressional elections, this news likely rattled the markets as political animosities and uncertainties about the election outcomes were already running at extremely high levels.
The president and the Fed in a one-way war of words. More commentary from President Trump questioned Federal Reserve monetary policy and the expected path of interest rates. While past presidents have at times commented on the Fed, and not always favorably, the ongoing critique out of this White House regarding the Fed and Chairman Jay Powell is now seeming to have short-term effects on the market.
Negative news from the housing market. Last Wednesday’s outset also saw the release of September housing starts, which fell more than expected at -5.3%, with construction in the southern region falling to its lowest level in three years. While Hurricane Florence certainly played a role in this report, it is likely rising mortgage rates did as well. This was only one data point in a weather-impacted month, but it likely contributed to overall market activity.
Assessing the earnings environment. As 3Q18 corporate profits roll in, it looks as though it will be another strong quarter, with the S&P likely experiencing year-over-year earnings growth of about 19%. This will also position Calendar Year 2018 S&P 500 earnings above 20%, which is extremely impressive. Despite this strong acceleration, the market seems to be focusing on 2019 when tougher comparisons will likely result in less dramatic earnings growth, perhaps in the 10% range. This was likely on the minds of investors following AT&T’s disappointing release Wednesday, which added to the downside volatility.
International trade and China’s economy. While most nations would be thrilled with 6.5% economic growth, this number on 3Q Chinese GDP released last week was below expectations and created more concerns about the ongoing tariffs between the United States and China. While the issues of U.S.-China tariffs have been evident in the market for several months, the lack of a resolution can take its toll on days like Wednesday.
Technical selling has likely contributed to recent declines. As stocks fall quickly in overheated short-term selling, indexes can often breach short-term support levels, which only exacerbate more selling when such levels are not held. We believe this happened when the S&P failed to hold 2870 earlier in the month (its January high), 2800 last week (its July breakout), and 2695 late Wednesday afternoon (the previous day intraday low). While these types of breaks can feel a bit scary, it is important to note they are trading-related and can serve just as much importance to the upside when the market is recovering.
Where we stand
With another rough one-day selloff in the books and October volatility now having put the major indexes into or close to correction territory, we feel it is important to emphasize the following:
We believe this market has become oversold. The Dow is now off more than 8% from its October 3 record high; the S&P has declined 9% from its high watermark of September 20; and the Nasdaq is off by more than 12% from its August 29 high. The Dow and S&P have now shifted into year-to-date negative returns on a price basis, despite the fact that annualized earnings growth has exceeded 20% since January.
Fundamentals remain strong. With GDP and earnings expectations continuing to look favorable, we believe the long-term environment for stocks remains constructive. Given what should be a third-quarter GDP report above 3% and 2019 corporate earnings growth anticipated to be in the 10% range, the foundation of this market in our opinion appears quite solid.
Valuations are reasonable. We believe stock valuations are reasonable with the S&P 500 price-to-forward-earnings multiple now below 15 times expected profits in 2019. This valuation level, we believe, allows investors to potentially recognize total returns at least in line with earnings growth.
Interest rates will likely continue to rise. At this time, we believe the Fed will likely hike rates in December and probably two more times in 2019. As we have said before, it is important to remember that rates are rising because the economy continues to remain strong.
Bond investors should consider lower-duration portfolios. As we’ve also said before, we believe fixed income investors can benefit from staying short on the curve and focusing on active portfolios managed with credit expertise capable of identifying improving opportunities in a strengthening economy.Brace for more volatility. This market has entered a highly emotional phase, and while long-term investing should always entail macroeconomic and individual company fundamentals, gyrations such as those experienced over the past few weeks can certainly test even the most patient investors. However, as history has shown, markets can strain emotions in the short term but typically follow fundamentals over the long term.
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