Investment Insights: A nightmare on Wall Street

Wade Balliet
Posted by Wade Balliet
Investment Strategy

This weekly report presents insights from our Global Investment Management team.

Male stock brokers conferring about one of many blue screens in the photo showing stock performance data.Trick-or-treat equity markets? Despite the treats strong economic fundamentals are giving to market participants, the real gifts this Halloween have been the tricks the financial markets have been playing on investors.

The broader U.S. stock market had one of its most challenging months in more than a decade, resulting in most of the positive returns garnered over the year dissipating in a cloud of smoke machine fog. The ghouls of the market overtook the S&P 500 from a high on September 20 of 2,930.75 down to 2,642.25. The price drop of 9.88% almost breached the “correction” territory marked by a decline of more than 10%. However, the U.S. equity market continues to remain the only major asset class with a positive return year-to-date.

We believe the sell-off level to be an overreaction as consumer confidence reaches a new 18-year high, corporate earnings continue to gain strength, and North American trade disputes get closer to reaching resolution. Concerns over equity market volatility and interest rate hikes have given investors more to consider than in previous quarters. However, the overall macroeconomic picture in the U.S. continues to remain robust, as unemployment reached a 49-year low at 3.7%, GDP growth checked in at 3.4%, and inflation held at 1.6% – well below the Federal Reserve’s target of 2%, despite some tariff concerns.

Furthermore, declines have occurred intermittently during the sustained bull market that investors have experienced over the last decade, and they have not derailed the broader market or economy. Long story short: the economic fundamentals remain strong, and this spate of volatility is a news headline-driven phenomenon rather than a direct economic and corporate earnings impact.

Much of the higher volatility that investors experienced in October was due to heated U.S.-China trade rhetoric, rather than concrete trade disagreement escalations. In contrast, and in more positive trade news, the U.S., Mexico, and Canada came to a joint agreement to maintain strong trade ties. Diplomatic tensions involving the U.S. and Saudi Arabia have captured much of the recent news cycle, but business between the two nations continues as highlighted by the $110 billion defense package signed in 2017, which remains intact.

Additionally, corporations have continued to report earnings that showcase incredible growth, with profits across the S&P 500 up 23% in the third quarter, according to Bloomberg. Simply put, earnings are at record-setting highs, but in some cases the market had even higher expectations. For example, Amazon, after becoming just the second company in history to reach a trillion dollar market cap, posted $2.88 billion in profits for the third quarter, 1,000% higher than last year’s figure, while increasing sales 29% to $56.58 billion. However, this sales number was below the average analyst estimate of $57.1 billion. With these analyst expectations in mind, and at the time of this writing, Amazon’s stock is down 23.59% for the month. While this is an extreme example, we see this month’s market selloff as an overreaction by many overly optimistic investors swayed by headline risk who have disregarded the continued trend of companies reporting strong earnings growth.

Overall, we believe this current overreaction to be based on geopolitical uncertainty, which would require another “shoe to drop” in order to dent positive consumer sentiment and business spending, and offset the trend in positive earnings reports. Share prices have a strong correlation to corporate profits, and extremely robust earnings over the last couple of quarters have helped forward valuations and expectations. Although risks remain in the marketplace, most notably tied to the Federal Reserve and impacts to oil price inputs within petroleum-producing regions, our team believes that the U.S. economy and its financial markets remain on sound footing.

Chart showing various market returns as of 10/30/18

Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.

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