What Caused the Drop? Our View on the Markets
October 11, 2018
By Mike Moreland • Vice President Investments
After a summer of calm and record highs on major U.S. market indices, we witnessed a significant one-day drop on Wednesday, and a subsequent large selloff on Thursday. This followed several days of smaller, less dramatic declines.
Two questions come to mind. First, what happened? And, more importantly, will this continue? Let’s look behind the headlines.
Why Did The Stock Market Drop?
No one event triggered this week’s selloff. Rather, the cumulative impact of a number of factors combined to turn a slow trickle into a waterfall:
1. Rising interest rates started to affect investment decisions in recent weeks. Stocks have had the world to themselves for a decade, with no meaningful competition for investor attention. Two year Treasury notes now approach 3.0%. The attraction of risk-free returns above the rate of inflation is pulling capital from the equity markets.
2. Global economic growth remains positive, but slower than the past several quarters. This reflects the natural aging of the economic cycle, and creates doubt about the sustainability of corporate profit growth going forward. Rising interest rates add to this concern. When perceived risk rises, volatility follows.
3. Tariff concerns and the risk of a trade war added another level of uncertainty to the mix. While this has been a headline issue for over a year, companies are now discussing the potential negative impact on material costs and earnings prospects. Investors are noticing and reacting.
4. Problematic valuations
particularly among the popular technology names. At quarter end, the S&P 500 was in the upper quartile of every major value measure looking back twenty-five years. Valuation is not a timing device, but the level of complacency present for most of the summer, combined with lofty prices, left little margin for error.
What it Means Moving Forward
While this market action is unsettling, it wasn’t unprecedented. Wednesday was only the 80th worst one day selloff since 1960. A bad day for points on the Dow, but not out of the ordinary on a percentage basis, and well down the list of record-setting drops.
Is this the beginning of the end? No. We’re in the latter stages of the economic cycle, but that does not mean a recession or bear market is lurking nearby. Economic growth, as noted above, is still positive. While the Fed will raise rates again, monetary policy is still neutral at worst. The first days of October have taken some of the speculative excess out of the markets, and that’s a positive for all long term investors.
We will continue to invest as normal – broad diversification, a focus on reasonable valuations, high credit quality, and low duration. Talk to your advisor to see where you stand today.