October 2018 Stock Market Volatility
The domestic markets have slightly pulled back from their high after a two day drop which we haven’t seen in months. Observers of markets continue to see spectacular earnings growth which has been close to 20% for the year. In fact, this growth has caused price to earnings (P/E) ratios to compress from high levels to start the year, to moderately expensive levels today. However, the strong earnings numbers have been offset with uncertainty around trade talks and increasing interest rates.
To date, we have witnessed two dips and a moderate correction (a correction is characterized as a drop of 10% from the peak). However, despite the volatility, the S&P 500 is up over 7% for the year. Going back to 1928, it is actually “normal” for the market to experience 3 dips (5% or more) on average per year. Last year was quite an aberration with none, causing many investors to become complacent during what is now the longest bull market in history.
Overall, the domestic economy has been flourishing in 2018 with solid fundamentals. Consumer confidence hit its highest level since year 2000, small business optimism is near all-time highs, and consumer spending has been rising. In addition to all of this, unemployment is at levels we haven’t seen for over 60 years.
Despite the favorable data, stocks have been volatile. Volatility has dominated over the last couple of days for two primary reasons. First, the US Federal reserve has continued to increase their short-term interest rates, and two, the trade war has continued to intensify, causing concern about future earnings. Inflation has been running right at the FED’s targeted level of 2% for the past few quarters. With the US economy running hot, the FED will continue to increase interest rates (as they have been doing since late 2015) to keep inflation at bay. Secondly, trade talks continue to be intensified between the US and China and we have seen further retaliations from both sides.
There are no indications that a US recession is imminent. Having said that, pressures continue to rise in the US stock market. Price to earnings ratios in the US continue to be elevated, interest rates are being increased, and the market will be more susceptible to shocks. In our view, because of the solid economic fundamentals in the United States, this pullback in early October isn’t “The beginning of the end”, but to be viewed as a buying opportunity for those entering the stock market.