News & Insights

Investors hoping for a year-end rally have instead been treated to increased market volatility.  A near 5% decline in its first week was the market’s worst start to December since 2008, though this drop followed what was the S&P 500’s best week in almost seven years.  The recent turbulence is reflective of an environment where both market bulls and bears have valid arguments to support their stance.

Topping the list of current concerns is the U.S.-Chinese trade dispute.  The market initially celebrated what appeared to be a positive meeting between President Trump and Chinese President Xi Jinping following the G20 summit.  This meeting resulted in a 90-day postponement in tariffs on $200 billion in Chinese imports that were expected to jump from 10% to 25% at the start of the year.  However, the initial positive interpretation of the meeting was subsequently brought into question given reports of “significant differences” in the two governments’ versions of what was agreed upon at the dinner.  Markets also did not respond favorably to President Trump’s tweet days after the meeting proclaiming himself a “Tariff Man.”

Despite October’s market drama, anxiety over the recent election, and hand-wringing over the durability of the economic expansion, the stock market seems to be on sound footing.  Economic growth appears solid and valuations are reasonable thanks to the impact of lower corporate tax rates.

Third quarter Gross Domestic Product (GDP) rose at a 3.5% annualized rate.  As always, there are pluses and minuses.  The most important component of GDP is consumer spending, which rose at a very satisfactory 4.0%.  Imports surged, which is not unusual when U.S. economic growth is faster than other developed countries.  Pre-buying ahead of tariff increases likely played a role as well. Imports have the effect of reducing GDP.  Largely offsetting this was higher government spending and increased inventories.

November’s midterm elections are likely to result in a divided congress.  Forecasting website FiveThirtyEight.com currently predicts an 85% chance that Democrats win control of the House but only a 19% chance the Senate swings blue as well.  A surprise sweep by one party could cause further asset price volatility as investors contemplate the implications for the important 2020 elections.  As 2016 proved, unlikely things can happen.

October is a famously volatile month.  1929’s Black Tuesday and 1987’s Black Monday both occurred in October.  This year, the S&P 500 dropped more than 5% during the first two weeks of the month.  Pullbacks of any magnitude have been rare during this long bull market.  One notable feature of this retreat was that it failed to spare the high-growth technology companies who had long been the market’s most resilient leaders.  Although smaller companies generally fared worse than large ones, Amazon.com and Netflix, both of which had approximately doubled over the prior 12 months, both dropped about 10% (Netflix would recover on the back of its Q3 earnings announcement). Alphabet—a.k.a. Google—has now only about matched the overall market over the past year.  Facebook fell way off the pace when its stock declined more than 20% in late July.  The unstoppable FAANG (an acronym from the first letters of these tech giants) trade is not necessarily over, but it looks vulnerable.

Against a backdrop of tariffs, Federal Reserve interest rate increases, and emerging market struggles, the S&P 500 steadily advanced to a new all-time record in late August.  This has now become the longest bull market in history, measuring 9½ years from the low of March 9, 2009.

Common sense would dictate that what goes up must come down.  However, in the long-term the market’s value is a function of corporate earnings growth, and that has been stellar.  According to FactSet Research, second quarter S&P 500 earnings growth was 25%, supported by a 10.1% sales advance.  Analysts expect third quarter earnings to grow 20% and full calendar year 2018 growth of 20.6%.  A one-time event, corporate tax reform has accounted for about half of the earnings increase, but accelerating sales supported by a strong U.S. economy is an ongoing market driver.

U.S. economic indicators appear quite strong and supported an impressive 4.1% annualized growth rate in second quarter Gross Domestic Product.  Underlying growth would have been 5.1% excluding inventory de-stocking; ups and downs in inventories typically correct themselves the following quarter.

Retail sales growth also remains solid, up 6.4% from last year.  After inflation, real retail sales growth is 3.5% and may be a reasonable measure of trendline economic growth.  Consumer optimism, an excellent employment environment, and the impact of lower withholding from last year’s tax cuts suggest spending growth will continue.