The past few weeks have been harrowing for investors, and since December, intraday price movements of the S&P 500 appear to be increasing. There have been five consecutive days in which the index has swung up or down 2% or more. Heightened intraday volatility usually precedes a change in market direction and is a key factor to monitor. We are constantly searching for a trigger to put a bottom in equities but for now investors are focused on the outcome of next week’s Fed meeting and its impact on interest rates, along with political tension in Europe and the UK as well as tariff and trade friction between the US and China.
The US Federal Reserve may have greater flexibility in their efforts to manage policy rates higher due to benign inflationary trends. The personal consumption expenditure deflator has eased in recent months after reaching a multi-year high of 2.34% at the end of July. Strong economic growth, rising inflation and comments made by Fed Chairman Powell in the early Fall months that the central bank was not close to interest rate neutrality were likely significant factors in placing downward pressure on risk assets in recent months. However, last week Chairman Powell said that interest rates were “just below” neutral in a speech to the Economic Club of New York, causing capital markets here and abroad to rally before yesterday’s sharp drawdown. Other critical headwinds include the concern regarding peak corporate earnings and trade-related friction.
We still have a preference for US corporate securities over the rest of the world but are concerned that comments from US central bank leadership can produce such powerful market outcomes. An encouraging sign is market leadership is broadening particularly in the developing world over the past several weeks. A stable or weaker US dollar along with a weakening interest rate pressure could also provide a tailwind for the emerging equity and bond markets.
After several months of outflows and painful underperformance, estimated money flows into the Vanguard FTSE Emerging Market ETF (VWO) — a popular investment vehicle — are picking up. Since its near-term bottom on October 29th, this particular security has risen nearly 6% after having fallen to a level last seen in early 2017. It may be early days, but this could be an encouraging development because the MSCI All Country World Index has only risen about 1.7% over the same time frame. Expanding investor interest in emerging markets may mark a point where appetite for risk assets begins to rise, which would be a welcome sign given the past two months of turbulence in global capital markets. We are optimistic on the prospects for emerging markets, especially Asia, in the long run. However, there are still significant headwinds—the slowdown in Chinese economic growth, the potential for continued trade-related friction, the strong US dollar and rising interest rates. Any stabilization in these factors could be supportive for further gains in the world’s emerging equity markets.
Today is Giving Tuesday. Numerous worthwhile charities are raising their hands and asking for our attention and our dollars in pursuit of their missions. The difficulty with a one-day campaign is that, while it may bring in new dollars from existing donor relationships, there is a low probability of establishing durable relationships with new donors. Whether the connection is spiritual or practical, driven by a single crisis or by a lifelong pursuit, connecting givers with worthy recipients is a process. Not only does a donor, whether organization or individual, need to find that alignment of purpose, that donor also needs to go through some degree of due diligence to see whether the receiving organization is a good steward of donated capital and creating meaningful and measurable impact with it over time.
Let today not just be a flash in the pan, but let it be the start of an ongoing process for kind and caring individuals, families, and institutions to discover and build long term relationships with impactful organizations creating positive change in the world. As part of that, donors should also consider solutions that help create a platform for purposeful giving that could last months, years or even generations. Consider donor advised funds (DAFs), private foundations, community trusts, and other solutions that make it possible to institutionalize giving, make larger financial commitments that can be disbursed systematically, and provide partners and resources to help identify and evaluate potential recipients.
With the 2018 midterm elections behind us, volatility continues to persist in global equities with many investors questioning whether the long-term uptrend in US stocks has reached its end. We are constructive on US equities based on strong corporate fundamentals and a supportive economic backdrop. Furthermore, if history is a guide, equities typically produce positive 12-month returns after mid-term election cycles.
Historically, fourth quarter performance has been favorable albeit not uniformly positive. The chart below (courtesy of Bloomberg TV) shows Q4 total returns of the S&P 500 going back 30 years. There have only been five negative quarters since 1988 and the overall average is 4.8% with the steepest contractions following the dot com bubble bursting and during the financial crisis.
The US Federal Reserve is widely expected to continue on its pathway to higher policy rates at the December FOMC meeting. For the time being, the US economy appears that it can handle a more normal interest rate environment. Yet, economic conditions in the rest of the developed world — notably Japan and the Eurozone — remain sub-par at best and interest rates in those economies are stubbornly low. We wonder if the higher trajectory of interest rates in the US will force higher rates elsewhere internationally or will lower international rates keep US rates lower than normal. We would prefer the former because if that occurred it could happen concurrently with economic recovery in the rest of the world. This relationship is critical, in our view, because it will likely continue to influence currency and capital market volatility going forward.
The euro has weakened considerably versus the US dollar this year and is currently testing support levels reached just a few months ago. Our concern is that there may be further weakness ahead as economic activity continue to be sluggish on the Continent – the key German economic engine appears to have stalled as the Bundesbank expects Q3 to exhibit zero growth although officials expect that to be temporary. Consensus forecasts (the dotted line on the chart below) may catch up to current prices placing further downward pressure on the currency. This is happening at a time when the ECB has indicated that it will begin to end quantitative easing exercises towards the end of the year.
The first investment decision for many asset allocators – the US equity-vs.-fixed income relationship – has broken a key long-term trend and support level. The ratio of the S&P 500 and US Aggregate indices (we use ETFs as proxies because we can obtain real time intraday measures) has fallen below it’s 200-day moving average, which is making US stock prices vulnerable. The last time this occurred was in mid-2016 before stocks began their recent run of dominance. As we have been discussing for the past several months, economic conditions and US corporate fundamentals remain strong and are markedly different than the tug of war we experienced prior to the stock breakout that occurred in mid-2016. In our view, the market is adjusting to the mix of higher US interest rates and slowing economic growth in key regions. We are in the midst of US corporate earnings season with some key companies lowering earnings and revenue guidance, putting downward pressure on those stocks. We believe that the current market adjustment is healthy and we will see higher US equity levels as we head towards the end of the year.
Stock markets around the globe continue to be highly volatile as key indices have sharply corrected since the beginning of October. By earlier this week, the S&P 500 had declined 5.6%, the Eurostoxx 600 had fallen 6.4%, the Nikkei contracted 6.3% and the MSCI Emerging Markets index had shed an additional 7.3% through the close on October 15th. As earnings season progresses, we are seeing positive results from major US financial institutions which are welcomed signs. Bigger picture, analyst expectations for future earnings and sales growth into 2019 and beyond (this week’s chart and admittedly an extension of last week’s) signal further expansion. The risk may be to the upside as strong US economic trends could propel sales and earnings above expectations. However, there are considerable risks at home with upcoming national elections and upward interest rate trends as well as challenging economic conditions in several key international regions.
International stock markets have been weak for several quarters measured in US dollar terms and it appears that may be affecting the US stock market. As of tonight’s (October 10th) close the S&P 500 has contracted 4.9% from its all time high reached on September 20 with most damage occurring in the past six days of trading. Today alone accounted for 94 points of the 144 point decline in the S&P price level. While the pain has been deep and swift as the market adjusts to a higher interest rate environment, economic trends remain supportive of further earnings, revenue and market gains. This week’s chart shows analyst expectations for S&P 500 earnings and sales levels, and it does not appear that the upward advance is rolling over or stagnating. That could change as earnings season arrives but, for the time being we view this sell-off as a bull market consolidation.
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