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October 2018 Intra-Month in Review
With the recent February-like volatility in the market I thought it would be a good idea to talk through our point of view in the markets and economy. There are many vantage points to look from when looking at a stock market in the aging part of an economic cycle. We believe that while we have tiptoed into this stage in the economy, it does not mean that the markets have no more room to run. In fact it doesn’t necessarily mean the economy has no more room either. This economic recovery has been the slowest as it relates to GDP growth (see Chart 1).
Chart 1: Source - JPMorgan Guide to the Markets, Aug 2018, page 18
We believe that this aging cycle in the U.S. has the opportunity to pick up steam as fiscal stimulus continues pump itself into the markets and trade tariff negotiating tactics resolve. We also believe that the passing of the mid-term elections will also bring clarity to the markets. Historically the best quarter of the presidential cycle is the 4th quarter of the midterm election year. So while October is the most volatile month historically, the markets have shown resilience for the following 12 months. As shown in Chart 2, there has never been a midterm election year where 12 months later the S&P 500 has not been positive; with the average return being 14.5%.
Chart 2: Source - LPL Research House of Charts
While we cannot predict then that the U.S. stock market will be positive for the next 12 months, especially based off of one historical metric, it still is one of the many indicators pointing towards a positive economy and market over the coming 12 months.
Some of the volatility this October is no doubt coming from the “peaking” of some key economic indicators, primarily company profits and the ISM manufacturing index. But if you look at both of those indicators (as we discussed in our mid-year outlook webinar) both of them show that an economy can be recession-free for an average of 4 years once the indicator peaks. Additionally the S&P 500 can exhibit positive returns between the peak and the recession. On average the S&P 500 returned 58.9% and 56.7% between peak-to-recession for company profits and the ISM manufacturing index respectively. (Source: LPL Research House of Charts – Outlook charts)
We cannot ignore the fact that there is volatility in the market; however we have to decide what kind of volatility is taking place. Is it the volatility of a deteriorating economy, or the volatility of an economy that is just growing slower? How you manage portfolios through the markets varies heavily depending on which economy you are dealing with. We believe that we are in an expanding economy still and that it is expanding at a slightly slower pace. We also believe that this economy has a long way to go. Following suite, therefore we believe the market volatility will find a support line and will continue its bull-market cycle. This week 160 stocks are reporting earnings out of the S&P 500. So far, we are tracking earnings growth of 22% for the 4th quarter; and we are paying 15.8x earnings (as of 10/22/2018). That is now below the 25 year average ratio of 16.1x earnings. Valuations are not hot, earnings are solid, and getting past the mid-term elections and finding technical support on this selloff, we believe will be a catalyst for the next leg of the bull market.
This is proving to be a very different year than last year. 2017 showed the death of volatility and a weakening dollar that created a great year for US and Non-US stocks. This year we have seen the dollar strengthen (although this may be short-term) and market volatility return. With interest rates rising and leaving the bond market at a loss in 2018, there is little room to hide from global market headwinds. Again though, we believe some of the headwinds are short-lived and that markets will return to their upward trajectory. Looking overseas, we believe the negative returns the international markets have handed us this year is an opportunity to take advantage of an overall international market that is trading at a 10% discount to its 20-year average valuation; with an indexed dividend that is 70% larger than the S&P 500 (see Chart 3).
Chart 3: Source - JPMorgan Guide to the Markets 4th Quarter 2018, page 44
So while the October markets have given us the “spook” it is so well known for this month, we don’t see it as a reason to run for the hills and de-risk portfolios. As always we will continue to monitor the changing landscape and keep you updated on our views of what is to come for the remaining part of the year.
A reminder, if you have missed any of our Month-In-Reviews you can find them archived on our website at https://www.aghwealth.com/p/month-in-review.
Thank you for your trust and confidence.
LPL Financial Advisor
Vice President, AGH Wealth Management
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly. All indicies are unmanaged and may not be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.