Stock Market Update – October 22, 2018

“A Watched Pot Never Boils” – Benjamin Franklin

Recently, stock market investors seem to be watching, waiting and anticipating the next bear market is soon to occur. As the fourth quarter began we saw a few air bubbles beginning to form in the lower portion of the investment pot, but boiling water was not readily evident. Despite some ugly days in the stock market this month, the Dow Jones Industrial Average (“DJIA”) and the S&P 500 are still positive for the year.

In times of market anxiety like the last few weeks, it’s appropriate to ask the question, is this normal stock market volatility or is this the beginning of a protracted bear market in stocks? No one can ever know for sure, but we believe this is just more of the same upsurge in stock market volatility we have been expecting all year. As we said in our First Quarter 2018 Review and Outlook:

“Normal financial market volatility seemed to have moved to another planet in 2017. However, during the first quarter of 2018, stock market volatility returned with a vengeance and will likely persist moving forward this year.”

We think it is useful to review how often the stock market experiences meaningful pullbacks. Based on data compiled by Capital Research and Management Company, over the 69-year period from 1948-2017, the DJIA declined more than 5% about 3 times per year, more than 10% about once a year, more than 15% about once every three years, and more than 20% about once every 6 years.

As we noted in our Third Quarter 2018 Review and Outlook, the stock market has not gone straight up since it bottomed in February 2009. We cited the following examples:

· 19.4% decline from April 29, 2011 to October 3, 2011

· 14.2% decline from May 21, 2015 to February 11, 2016

· 10.1% decline from January 26, 2018 to February 8, 2018

While it is good to remind ourselves of the regularity of stock market declines, we understand the psychological pain most investors feel when they see the paper losses in their portfolio caused by swift market sell-offs like the 832 point or 3.2% plunge experienced by the DJIA on Wednesday, October 10th. Unfortunately, days like this occur more often than most of us realize. Single market day declines of 3.2% or more have occurred three times this year on Feb. 5, Feb. 8 & Oct. 10. Over the last 90 years of data, daily sell-offs of this magnitude have happened 250 times. That’s an average of more than two times a year.

The Prudent Speculator newsletter sums up the points we are making above with the following statement, “Sell-offs, downturns, pullbacks, corrections, and even bear markets are events that equity investors always have had to endure on their way to the best long-term performance of any of the financial asset classes.”

So, what’s happened since the end of the third quarter?

Negative events

· 10-year US Treasury yield spiked from 3.05% at the end of the quarter to 3.23% on October 5th and ended Friday at 3.20%. This is a rapid increase in interest rates for the usually slower moving bond market. This sharp increase over the last few weeks has caused concerns in the financial markets that if rates rise too fast, they could prematurely stop the economic expansion. The 10-year US Treasury rate is an important benchmark rate for the economy. It influences how much we pay for mortgages and other consumer and business loans. It also has implications for the US budget and affects equity valuations. We will continue to monitor the bond market to assess the signals it may be sending.

· On October 8th, The International Monetary Fund “IMF” issued an updated forecast for global economic growth for this year and next year. The IMF now expects the global economy will expand at a rate of 3.7% vs. their previous forecast in April of 3.9%. They see continuing positive global growth, albeit at a slightly slower rate of growth. Their updated forecast still sees the US growing at 2.9% this year, unchanged from April. We find the US stock market’s concern with the IMF report somewhat ironic. US investors were just recently concerned the US economic growth was coming in too strong, so a slight slowdown in global growth would not seem to be a major negative factor.

Positive events

· Third quarter earnings season has started. As of Friday, 17% of the companies in the S&P 500 have reported quarterly results. Of the companies that have reported Q3 results, 80% had positive earnings surprises (i.e. they made more money than everyone was forecasting). Approximately 64% of the companies that have reported had positive sales surprises. The year-over-year earnings growth rate for the third quarter is now expected to be 19.5%, once all the companies in the S&P 500 have reported. This is above the 18.9% growth rate projected just last week. Company earnings continue to be headed in the right direction.

· The latest inflation numbers were released on October 11th. Year-over-year inflation, measured by the Consumer Price Index “CPI”, came in at 2.3%, below consensus forecast of 2.4% and slightly above the Feds stated target of 2.0%. Inflation continues to be relatively tame, which is good news for investors.

In addition to the events above, we have had our fair share of negative US and World news events in the last few weeks. Headline events have included the contentious vote for Supreme Court Justice Brett Kavanaugh, the death of a Washington Post journalist in the Saudi Arabian embassy in Turkey, Italy’s budget standoff with the EU, the U.S. Ambassador to the United Nations resigning, UK’s continued Brexit struggles, Hurricane Michael, and more. However, it seems we always have plenty of negative headlines to debate and worry about. The good news is that most events are just noise and should be ignored when making long-term investment decisions.

What happens next?

We still believe that the current bull market remains intact. However, until we receive some clarity on trade, the Fed’s interest rate policy and the midterm elections, we will likely continue to see heightened market volatility in bonds and stocks. As we said in our latest quarterly commentary:

“Despite the headwind from rising interest rates and the ongoing trade tensions, many leading indicators for the overall economy continue to exhibit positive signs. As mentioned before, consumer confidence is the highest it has been in eighteen years. Unemployment is low, and wages are rising. Both have supported strong retail sales numbers. Leading indicators typically begin to exhibit weakness for a year or more before a recession ensues. Current US economic growth remains positive and supportive of higher stock market returns.”

The positive factors mentioned in our latest quarterly commentary remain largely intact. We continue to be cautiously optimistic about the stock market in the short-term and decidedly optimistic over the long-term.

As Peter Lynch reminds us, “the secret to making money in stocks is not to get scared out of them”. We are confident that if you take a long-term view of your stock portfolio, you will see more ups than downs.


Marietta Wealth Management, LLC