News

The October Narrative  

Talk about a change in narrative.  When it comes to financial markets, the last few weeks of October provide a great example of how quickly gains can vanish but also a reminder of how normal such occurrences are historically.  Entering October, the S&P was up nearly 10% YTD, 3Q earnings expectations were superb, and the U.S. economy was on point. By month end, we had tied the longest streak of consecutive down days (28) for the S&P 500 in the post WWII period and booked the worst monthly performance since September 2011.  Regardless, equity selloffs of this nature are not abnormal and the absence of any notable change in fundamentals or exogenous shock led us to a clear and resounding message: stay the course.

Market Anecdotes

• Risk markets capitulated near correction territory on a blend of trade conflict, rising interest rates, and concerns surrounding peak earnings/economic growth.  Debate ensued as to whether the volatility is garden variety correction or end of the business cycle.  We favor the former.
• Both swiftness (24 days) and size (-9.3%) of the drawdown have been notable.  In the history of the S&P 500, declines of over -7.5% in less than five weeks has happened only 19 times.
• Despite White House narratives, we expect U.S.-Sino trade conflict to persist into 2019 based on recent hard line speeches from President Xi which make it complicated for him to compromise.
• Markets are grappling with rising interest rates, but we remind clients it is not the direction of interest rates so much as the absolute level of interest rates that tend to impact markets.
• Strong earnings growth and two market corrections in the past 12 months has 2018 currently ranking as the third greatest decline in P/E multiples since 1976.  As of November 2, the S&P 500 forward 12mo P/E ratio was 15.6 with blended earnings and revenue growth of 24.9% and 8.5%.
• U.S. manufacturing PMI featured a 5-month high level of new orders but slowed from highly elevated readings over the past six months.  Cost pressures from higher input costs and tariff-related pressures on metals were frequently cited.
• October saw inflation expectations decline as evidenced by 10yr B/E yields falling from 2.17% to 2.5% at month end and high yield spreads widened by 21% from 316 bps to 381 bps.
• Despite headlines touting a 14-month low in Chinese Treasury holdings, their reduction ($10b) was actually smaller than Japan’s ($30b) and overall relatively inconsequential in the context of their $1.165t in overall holdings.
• With the November elections looming, we thought it would be a good time to offer some historical election cycle observations:
  • Data since 1949 show the ‘prime the pump’ year three of a first-year Presidential term averages 19.2%, far and away the best of the 4-year cycle.
  • Since 1950, the S&P 500 has been positive 100% of the time in all 6-month and 12-month periods following midterm elections.
  • The 1950-2014 average 12 month return for the S&P 500 following midterm elections is 15.3%.
  • The average correction in a midterm election year is 19% and the average return 12 months thereafter is 31%.

**Past performance is not indicative of future returns**

Economic Release Highlights

• Third quarter GDP beat expectations at 3.5% backed by robust consumer spending growth of 4% (Q2 3.8%) which contributed 2.7% to GDP, strong 3.3% growth in government spending which contributed 0.6% to GDP, and a material $76.3b rebuild in inventories which contributed 2.1% to GDP.  Business investment, housing, and trade deficit data were disappointing.
• October wage growth of 3.1% marked the highest annual growth since 2009 but the metric was impacted by a depressed 2017 readings and the month/month rate slowed to 0.2% from recent monthly readings of 0.4%/0.3% levels.
• 250,000 new jobs in October far exceeded estimates of 190,000.  Headline unemployment registered 3.7% and annual wage growth climbed 0.3% to 3.1%.
• September headline and core PCE both came in right at the 2% Fed target.  This metric has moved notably higher from summer 2017 levels but has been relatively flat since March 2018.
• October consumer confidence held strong at 137.9, despite financial market volatility.  The index is near an 18 year and all time high of 144.7 reached back in 2000.  The strong job market is translating to no concern in consumer-ville.
• October Manufacturing PMIs, while still expansionary, revealed slowing conditions particularly out of Europe and EM Asia which are notably to the downside.  Services PMI readings remained healthy with a global average of 53.3.  Composite readings remained expansionary with Global (52.2), U.S. (54.9), Eurozone (53.1), and Japan (52.5).
• October’s ISM non-manufacturing index slowed slightly from September to 60.3 but carried strong new orders (61.6) and export orders (61.0).  September and October were the first every back to back > 60 readings in the history of ISM Services Index.