Relief Around the Bend? – Week Ended 11/2/18

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”.

From an economic perspective, it may be too easy or simplistic to claim that jitters endured by the market during the month were not without any merit.  Sure, corporate earnings are coming in again more than 20% higher when compared to year-ago levels and are an undebatable positive.  No economic recession has ever begun when corporate earnings were still rising.  Unemployment near all-time lows and a consumer that is enjoying some wage growth is also a support.  But financial markets are forward-looking and as we come upon the 12 month anniversary of tax reform/cuts, comparisons to 2018 levels will become more challenging.  Robust earnings for 2018 are old news, and “peak growth” concerns both in the US “suddenly” have merit (even though it’s been well discussed all year).  The Fed is also somewhat boxed-in; historic-low unemployment levels and robust nominal GDP growth suggest that continued interest rate hikes are not inappropriate.  But higher interest rates at some point ultimately present a drag for big-ticket consumer purchases (like housing and autos), as well as companies with significant debt service and by extension the economy.  The level of interest rates the US economy can tolerate is arguably much higher; but the level investors are comfortable with remains anchored lower.  At the same time, investors have been regularly tormented with wars of words between President Trump and other major economic powers all year when it comes to trade-related rhetoric.  So the growing perception throughout most of October that the Trump administration is comfortable with a protracted new cold war with China was unwelcome news.  Is it that the Stock market vigilantes finally heard enough and wanted to send a message that an all-out trade war will not be tolerated?


Bottom line: we can probably blame Trump and Fed Chairman Powell for the sudden bad behavior of the markets.  But as painful and uncomfortable an experience as October was, it is not that uncharacteristic for a midterm election year.  In fact, the typical midterm election year since 1950 has experienced an average pullback of -19% according to Strategas Research.  With the ugly partisan showdown coming to a head tomorrow, midterm election uncertainty will finally disappear.  We’ve cited often in recent months that midterm election years are go-nowhere experiences on average thru October, but marked with strength during the 2 months following a midterm.  Last week it felt like the negative pressure being exerted on the markets over the recent 5 weeks began to thaw; in fact the S&P500 actually logged an advance of +2.4% over the five trading days ended November 2.  Interestingly, the better market behavior coincided with what appeared to be early development of a slight thaw in the impasse between Trump and China over trade.  So aside from the removal of the midterm election uncertainty, it would seem logical that any de-escalation with China could hold meaningful improvement for equity investors both here and abroad.  Another historical anecdote we are mindful of: since WWII every 12 month period following a midterm election was positive.  The cynic would say that coming off the lower starting spot following October this year should be easy; but it still suggests investors would be unwise to get too pessimistic or throw in the towel.  One thing about October – it certainly erased any possible euphoria that could have been building in investor sentiment!


PS – be on watch for our monthly commentary to post to these pages in the coming days.

Posted in Blog Post.