At the end of October, one could almost gather that a some modest relief was returning to the financial markets as the ugly but much anticipated US midterm election drew near and uncertainty over its outcome would be no more. As it turned out, election day generally went as predicted by political pundits – that Democrats would take back the house, but Republicans could hold their majority in the Senate. The fracture of Republican control renews what is often referred to as political gridlock. Citizens will often complain about gridlock or political dysfunction, but investors see it more favorably because the probability of significant policy changes are perceived lower when political parties are at odds with each other. In this day, it also mostly removes the possibility of Democrats pursuing impeachment of Trump or a wholesale rollback of policies implemented during his first two years (which would not in any way be market friendly). On the split-power result, US equities enjoyed a strong start to the week and post-election bounce on Wednesday. That bounce, which led some to cheer that a hoped-for 4Q rally might now get underway, were cooled Thursday and Friday as the Federal reserve reiterated its intent to continue raising interest rates. Still, the strength by markets early in the week was enough to help the S&P500 conclude firmly in positive territory for the week with an advance of +2.2% on the S&P500.
In recent days we executed several tactical adjustments in the fixed-income sleeve of client portfolios. We sold or reduced exposure to short-maturity bond funds and reinvested proceeds into position-traded money funds. These adjustments take advantage of attractive yields available on short-term money funds relative to the variable return potential on short-maturity bonds in a rising interest rate environment.
One word comes to mind when thinking of the drawdown endured in October: relentless. It was the worst month for US investors years with 16 of the 23 trading sessions during the month being negative. Worse than that, since the S&P500 made its last all-time high on September 20, 75% of all trading days were negative and the major US stock indexes flirted with technical correction – a term defined by a drawdown of -10% or more. The retreat was most severe in those areas of the stock market that to this point, performed the strongest. “FAANG” names (Facebook, Amazon, Apple, Netflix, and Google) were punished one after the next for either softer-than-hoped quarterly earnings or more sober forecasts of quarters to come. As bad as it was, perhaps the most discouraging development was that diversification provided almost no relief. Even the safest of bonds, which historically offered investors a destination of safety and could be counted on to rise during times of severe market stress, also forfeited ground during the month muting their benefit. International equities, of course more risky than bonds but experiencing troubled times throughout most of 2018 fared even worse than domestic (how much further can they fall?!). One story appearing in the Wall Street Journal went so far as to call diversification “dead”.
We last wrote a “Market Alert” about large stock market movements on August 24, 2015. That fact in itself highlights that it’s been an infrequent occurrence over much of the past two years that investors felt much discomfort. Large market swings or accelerated volatility in stock prices is never a welcome experience – even if we admit they are more common than witnessed throughout much of 2016 or all of 2017. Even long-term investors who are aggressive, maybe opportunistic, and sitting on a lot of cash to invest do not welcome market drawdowns. Yet, market downturns provide opportunity to invest when companies are on sale.
The weakness that began to unfold in early October continues on is arguably intensifying as the month matures. As noted in our update earlier this week investors increasingly seem acutely focused on the well discussed risks rather than what can or is still going right (seemingly old, boring news). In recognition that our notes earlier this week (notes for week ended 10/19) and in the prior (Halloween Arrives Early) did a fairly comprehensive job of highlighting those key fundamentals and risks the market is weighing, the bottom line is that we believe as this pullback matures it is increasingly of technical nature. Said differently, it is decoupling from fundamentals and being fueled off what is mostly technical behavior. This includes program/computer/algorithmic trading; the type of trading that causes “babies to be thrown out with bathwater” (or all stocks trading similarly, despite unique business characteristics of each company). Being that it increasingly appears a technical pullback, it seems appropriate to highlight some technical signposts of what to look for when trying to understand how much longer weakness may persist – a question likely on most everyone’s mind following a session like today.
Despite continued skittish trading behavior and large daily gyrations, shares of US equities concluded the week ending October 19 roughly unchanged from where they began. The S&P500 finished less than -0.01% lower while the more concentrated Dow Jones Industrial Average added +0.4%; perhaps the broadest domestic measuring stick, the Wilshire 5000, also concluded essentially flat for the week, but is off -5.5% month-to-date and brings the year-to-date performance to a very scant +2.8%. With the reality that markets look dramatically more concerned than just 3 weeks ago (at September 30), the most natural question one might ponder is, “what is so different to justify the dramatic tone change?”
What a difference 8 days can make! After turning in the best quarterly performance in several years, the new month and start of 4Q has been no friend to investors. If you’ve been following the financial media at all in the last week or so, you are aware that the recent market stress is being attributed to a swift upward adjustment in bond yields. Most notably, yields on US Treasuries (particularly the 10 year) have quickly increased as the bond market seems to finally be responding to the stronger than trend economic growth in progress. This strength, when coupled with unemployment hitting its
lowest rate in 49 years (recent tick 3.7%) is being extrapolated to mean more robust wage growth is on the short horizon, and wage growth is historically the primary driver of broad-based inflation. And, if Continue reading
US indexes continued their ascent higher during the third week of September, with the S&P500 adding +0.9%. The Dow, which tends to be a bit more heavily influenced by industrial sectors and the traditional goods-based economy (rather than services), fared even better with its add of +2.3%; that narrows its relative performance disadvantage against more services and technology focused sectors which are generally leading the domestic charge higher YTD. Transportation and Industrials, two areas watched by Dow theorists for economic signal, have also outperforming the broader market recently giving encouragement and a more optimistic thesis on the prospects for the market to continue on its march higher. International markets, which have been the most notable black-eye for diversified investors and those believing foreign markets represent a less expensive opportunity set, are also enjoying relative outperformance so far in September.
The month of September started a bit challenged following very strong runs in July and August; that is until last week when the S&P500 managed to rebound and conclude the week higher by +1.2% and bring the index back to a little better than break-even for the month-to-date. With the latest week, the S&P is now up a handsome +10.2% in 2018. The figure is remarkable considering US equities moved -12% lower between late-January and early-February and spending the better part of 6 months fighting to fully recover against a volatile political and global trade backdrop. International markets generally cannot claim the same resilience however. Emerging markets are off -9.2% YTD (and in bear market territory from their highs earlier this year); developed Europe is also negative YTD. Even within the US, performance is extraordinarily bifurcated; growth (tech, healthcare) enjoys a more than 1000 basis point favoritism vs. value (think energy, utilities, consumer staples). This growth-over-value bias is a carryover from much of the last several years, but made even more extreme in 2018. It is tempting to wonder if value (or international for that matter) will ever enjoy a sustained period in the sun again.
Despite ongoing financial stress emanating from the likes of Turkey and other emerging market economies in recent weeks, the US stock market (S&P500) managed to finally inch above the prior all-time highs set back in January. If that alone doesn’t speak to how resilient is the US stock market, it is also worth mentioning the political environment remains extremely challenging for Trump & Co., and by all expectations would signal that mid-term elections in November will result in a shift of control in Congress. Such an outcome would seem likely to further reduce what is already limited political capital for the balance of his 4-year term if not create increased uncertainty of impeachment. At the same time, weakness in international markets implies the globally synchronized growth story is dead just 12 months after it was first embraced and international was believed to be a better value and return opportunity. Most discussed this week however is that the current bull market being enjoyed in the US just became the longest such run in history, stealing the title from the 9.5 year period encompassing October 1990 to March 2000. This current run is not yet as powerful in terms of gains as the former, but make no mistake that the age of this run will be more loudly cited as one of the most compelling reasons to anticipate its end.