Gill Capital Partners October 2018 Market Update
Given the market volatility over the last two weeks, we would like to take time to share with clients why this may be happening and what our views are, and provide data to help us all maintain perspective. These are the times in which the media loves to flash large red font and descriptive words such as “plunge” and “crash.” However, this market move is consistent with healthy corrections that the market must go through to push higher over the long run. While these times can create emotional responses, we vow to bring sound judgement and a fundamental perspective to portfolio decisions.
U.S. markets are now roughly flat for the year. The NASDAQ has entered correction territory, down over 10% from its highs, and the S&P 500 and Dow are now off 9.4% and 8.5% respectively from their recent highs.
We have identified four key areas that the market is currently focused on:
Interest Rates and The Federal Reserve
Current Update– The Fed has been steadily raising interest rates to the current target range of 2.0% to 2.25%, and forecasts suggest they will likely raise rates by another 0.75% over the next year. Interest rates across the U.S. Treasury curve have been moving higher, with the 10-year U.S. Treasury now yielding 3.11%. Many investors believe that rising interest rates create a headwind for stock markets, as increased rates may have negative growth effects on the economy.
Our View – Yes, interest rates have been rising. However, there are two very important points to look at: 1) Even if the Fed continues to raise rates and the Fed Funds Rate reaches 3% or even slightly higher, this is far from a restrictive policy, and 2) Periods of rising rates almost always coincide with market gains. From a recent Vanguard study that looked at data over the past 50 years, including 11 different periods where the Fed raised rates, the market rose in 10 of the 11 periods. The average annualized return over these time periods was 10.3%.
Earnings and Current Valuations
Current Update – Corporate profits have been booming in recent quarters. In the 2nd quarter of 2018, the last full quarter of earnings reports, the per-share earnings for companies in the S&P 500 rose 24.8% over the 2nd quarter of 2017. The primary questions coming from analysts are, at what level can earnings continue to grow, were the tax cuts just a “sugar high” for earnings, and will tariffs really have an impact?
Our View – Earnings and valuations are fundamental to the direction of markets and we look at this metric closer than any other. We love fundamental information! Let’s throw out earnings (for the sake of tax naysayers) and focus on sales. In the last full quarter of reports, sales by S&P 500 companies grew by 9.5%, the fastest rate since the fall of 2011.
Yes, taxes and share buybacks are helping…but growth remains intact. Thus far, earnings from the third quarter, in large, have not disappointed. The threat of tariffs has the potential to impact large industrial companies, but we continue to believe this is a political negotiating tactic.
Current Update – We are entering a historically positive time for the stock market, which consistently follows market weakness in September and October. Interesting fact, 5 of the stock market’s worst 10 days have taken place in October.
Our View – While most investors tend to think in terms of years, looking at returns over quarters reveals some stunning trends. One of these is the remarkable history of positive returns in the fourth quarter for equity markets. Looking back three decades, the S&P 500 has gained at least 2% in the fourth quarter 25 out of 30 years, and has averaged more than 5.25% over that time. Yes, there have been some negative years, but this time of year has driven positive returns over 83% of the time.
Current Update - Another remarkable trend we have followed is the performance of stock markets following midterm elections. The months leading up to midterm elections have been historically volatile, due to negative headlines and political uncertainty, but is most often followed by policy clarity and a positive investment environment.
Our View – Since 1946, the S&P 500 has not declined in the 12 months following a midterm election. The average price return of the S&P 500 in the 12-month period following a midterm election has been 15.3%. Midterm election years have consistently seen volatility leading up to the election, which have been followed by solid positive returns in the year that followed.
Taking into account the key inputs above, we continue to believe that fundamentals are strong. Interest rates, while higher, are not restrictive to growth. Corporate earnings continue to impress. We are moving into a seasonally supportive time to own stocks, and midterm elections will soon be behind us. All of this leads us to believe that this is a normal correction in an ongoing bull market. Many of the indicators we watch tell us that this market is at or approaching very oversold levels and is due for a bounce. We will be watching earnings closely as they come in over the next couple of weeks.
As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.