October 30, 2018

The stock market can be a larger-than-life enigma during times like this. Investors digest tons of economic and earnings data of what “has been,” but we receive little reliable data of what “will be.”

After four weeks of broad market losses, investors now fear that all the rosy data coming in from the third quarter will give way to signs of slower-than-expected growth from the current quarter.

At least that’s my take on it.

The blame game is everywhere, and it starts with the Fed. The minutes from the September 25-26 Federal Open Market Committee (FOMC) meeting, released on October 17, lived up to their advanced billing, that is, that the FOMC would likely continue to pursue a gradual rate-hike path.

That gradualist policy, however, is of little comfort now as Wall Street has determined that the Fed isn’t on the same sheet of music when sizing up the economy. The target range for the fed funds rate was raised to 2.00% to 2.25% at the September meeting. Meanwhile, the latest projection from Federal Reserve Board members shows the median estimate for the long-run rate is 3.00%, implying there could be at least four more rate hikes; and yet the minutes have left an opening for further additional rate hikes once the 3.0% long-run rate is reached – a message reflected in the following passage from the minutes:

“A few participants expected that policy would need to become modestly restrictive for a time and a number judged that it would be necessary to temporarily raise the federal funds rate above their assessments of its longer-run level in order to reduce the risk of a sustained overshooting of the Committee’s 2 percent inflation objective or the risk posed by significant financial imbalances.”

Market participants see this directive as an increasingly hawkish posture, and yet there was the additional commentary stating that incoming data and its implications for the economic outlook would drive future adjustments to the target range for the fed funds rate. That implies this outlook for more rate hikes could be scaled back if the incoming data threatens the FOMC’s objective of sustaining 2.0% inflation.

Only time will tell, but for now the minutes have largely confirmed to the stock market that the FOMC expects to keep raising interest rates. Right or wrong, the market perceives that the Fed will tighten, in light of more recent softer housing, auto, and retail sales data. And this same perception has the dollar trading back up to its 2018 highs against most major currencies, adding to the cumulative concerns of the perceived future impact of further rate hikes, forex headwinds, a third wave of tariffs, and the wild card of the Republicans losing the House and/or the Senate, as the mid-term elections approach.

The Numbers Still Support a Healthy Stock Market

Now for the good news. It should be noted that the 10-year/2-year spread has improved to 31 basis points from a low of 19 bps that had everyone on an “inverted yield curve watch” (see chart, below).

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

Also, the spread between junk bonds is 358 bps, right about where it started the year. If the threat of a serious economic slowdown were looming, junk spreads would be blowing out.

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

And lastly, the five-year forward inflation rate is currently 2.20% and below the 2.35% reading in January – a very tame inflation future indicator. Put simply, this is not the stuff of an economy about to roll over.

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

So, by and large, U.S. credit markets are in excellent shape, which can’t be said for the rest of the world, and because of this condition, global fund flows should continue to find their way into U.S. debt and equity assets. And as far as corporate profits are concerned, the market’s angst about next year’s estimated growth rate of 10% being cut in half seems unfounded, at least for now.

With 48% of the S&P 500 companies reporting third-quarter results, 77% have come in above estimates. Looking forward, 41 have issued negative guidance while 15 have issued positive guidance, which is a lower percentage than the historical average (Source: FactSet Earnings Insight – Oct. 26, 2018). With the S&P 500 forecast to earn $178.19 in 2019, the index is trading at a forward PE of 15x – hardly expensive.

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

In the wake of this month’s stock sell-off, bond yields have retreated along with prices of many leading commodities that, in addition to the rising cost of money and a stronger dollar, were a source of growing concern to corporate profits. Due to lower commodity prices and lower inflation, we’re just not hearing that level of concern from most companies within their post-earnings calls, but that rationale is having little effect on the “sell first, ask questions later” mentality that has gripped investor sentiment lately.

After the second wave of earnings and corporate guidance crosses the tape this week, and the mid-term elections show what should be the Republicans retaining control of the Senate, the market will likely stabilize. But between now and Election Day, the market may be highly vulnerable to further volatility.

Won’t it be nice when the actual numbers that support a bullish U.S. economy and stock market going forward – and not just emotions, based on fear of the unknown – start to matter again?

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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