October 16, 2018

The stock market shed its Teflon coating this past week in what was a nasty short-term correction, where the S&P 500 shed roughly 7% in seven trading sessions. Taking a rear-view mirror look as to why the sharp breakdown occurred at the time it did deserves examination, not only to understand why, but also to glean from the events whether the correction has run its course, just as earnings season is about to unfold.

From my vantage point, the selling was triggered by a confluence of events, some of which began during the last week of September and then came home to roost in the opening two weeks of October.

Aside from the obvious finger-pointing at the Fed’s decision to raise interest rates and the subsequent pop in Treasury yields that got the selling stone rolling downhill, there was a rising level of anxiety that fueled investor fears. Leading up to the September 25-26 FOMC meeting, there was already evidence of weakness in the real estate, semiconductor, materials, and financial sectors in highly active sector rotation.

And while the Dow, S&P, and Nasdaq traded at new all-time highs October 1-3, on the back of a few mega-cap stocks, there were already some leading stocks beginning to pause. At that point in time, the stock market was technically overbought on a purely short-term basis, and few market participants would argue with that view. Also, the sharp breakdown in Chinese, European, and Emerging Markets from many months prior had finally caught the attention of investors comfortably camped out in U.S. equities.

Here are the 12-month charts of China Shanghai, Euro Stoxx 50, and the MSCI Emerging Markets Index:

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Heading into October, investors had to digest a flurry of political headlines and the latest policy statements from the Federal Reserve, which included another rate hike, the third one this year.

The U.S. at last implemented tariffs on $200 billion worth of Chinese goods, which triggered Beijing to impose retaliatory tariffs on $60 billion worth of American products. Chinese officials also canceled mid-level trade talks that had been scheduled for later in the week, dashing hopes for a near-term resolution.

Additionally, OPEC and several non-OPEC nations failed to reach agreements to increase crude oil output in order to counter falling supplies from Iran due to U.S. sanctions. President Trump criticized OPEC in front of the UN General Assembly, saying that the oil cartel is “ripping off the rest of the world” by colluding to limit supply and prop up prices. President Trump also called Iran a “corrupt dictatorship,” telling the United Nation that its leaders “sow chaos, death, and destruction.”

Future Fed Policies Will be Based Entirely on Future “Unknowns”

The policy directive coming out of the late-September FOMC meeting wasn’t a big surprise. The fed funds rate was raised 25 basis points to a range of 2.00% to 2.25%, which everyone expected, and the vote was unanimous, which wasn’t a surprise, either. Their projections for PCE inflation and core PCE inflation were steady between 2.0% and 2.1%, which means they see no big rise in inflation.

In the Q&A portion of Fed Chairman Powell’s press conference, he acknowledged that an inflation surprise to the upside would be a risk for a more aggressive tightening cycle, yet he quickly added that the Fed does not see that in its forecast. Powell also clarified that it is very possible the Fed would CUT rates in the event of a noticeable downturn in growth. The lack of a clear crystal ball was the major takeaway of Powell’s presentation. That was by design, as Powell has an even-keel delivery predicated on a belief that the Fed’s monetary policy actions are not to be considered preordained. They are subject to change.

The implication that the fed funds rate may move higher in 2019 and 2020 is based on how the Fed thinks the economy will evolve in the interim, based on Powell’s positive outlook in his prepared remarks, which acknowledged that the current U.S. economy is strong. Despite these clarifications, however, the Treasury market had its own bearish interpretation of matters that spilled over into the stock market.

So, while the recent pullback for the U.S. equity market might cause alarm bells to be going off, from a longer-term perspective it looks as if what has just occurred is a garden-variety correction. The weekly chart of the S&P 500 (below) demonstrates how today’s stock market tends to get overbought more frequently than in years past, much of it the work of algorithms that trigger the further buying of stocks when new highs are established, or the inverse when sell programs hit – like what just happened.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

In other words, the computer cuts both ways, and after Friday’s close, the S&P is trading back down to the low end of the long-term primary uptrend line that has defined the bull trend.

Rather than try to dissect any further what all these converging forces will do next, let’s let the upcoming earnings and guidance season provide the evidence as to whether all this “paralysis by analysis” is warranted. The time-honored adage of “sales fixes everything” still holds true, especially for the stock market. If the companies that make up the S&P can show 6% to 7% third-quarter revenue growth, as is currently forecast, and more importantly, guide to similar top-line growth in the fourth quarter, then the past two weeks will have been viewed in the rear-view mirror as one heck of a buying opportunity.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license.


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