Market View (October 2018) – Volatility: Déjà vu All Over Again

by Daniel Yu, CFA®, AIF®, REDW Stanley Financial Advisors

In the first two week of October 2018, we have seen a fairly rapid decline in market values. At the time of this writing, the S&P 500 has declined about 6.2% during the month of October with developed international equities performing in a similar fashion and emerging market equities performing worse. Ostensibly, it is valuations, rising interest rates and trade tariffs that are to blame. We added “déjà vu all over again” to the title, because we were in a similar situation as our February 2018 newsletter.

In February, the forward Price Earnings (P/E) ratio on the S&P 500 was about 18.2x; as of 9/30/18 it was 16.8x.  In other words, the expected gains in earnings in the S&P has grown at a faster pace than the price appreciation in the S&P 500, despite the S&P 500 having an approximate gain of 10.6% as of 9/30/18.  Moreover, the long term average in forward P/E is 16.2x.  Some might argue that all of the gains in earnings have come from a “sugar high” from the tax cut, but that is not correct. We have seen both revenue and earnings growth throughout 2018, and the expected growth in earnings continues. So, if equity valuations are near the average and earnings continue to grow, what of the other supposed reasons?

Interest rates have been climbing through most of the year with the Federal Funds rate at 2.25% vs. 1.5% at the beginning of the year, and the US 10 Year Treasury at 3.15% vs. 2.4% at the beginning of the year.  So fixed income does offer a better yield than at the beginning of the year, but it is not so compelling as to convince us to make changes to our investment models or change our outlook for GDP growth.

What of trade tariffs? We have held that tariffs are a negotiating tactic of the present administration, and we discussed this in greater detail in our July 2018 newsletter. Trade with China is much less important to us than trade with Canada and Mexico, and with recent trade announcements with those two nations (as well as Europe), trade tariffs should not be such an important issue moving forward. From a global growth perspective we continue to see a general atmosphere of economic growth with manufacturing continuing to show expansion in most countries. Finally, domestic oil production is now greater than in either Russia or Saudi Arabia, and current estimates are that the US will be a net exporter of energy by 2020, which will mean a new revenue source for the nation.

Here at home we see solid growth in jobs and compensation continuing to fuel economic expansion. While market declines are never fun, we continue to have a constructive outlook for the US economy and equity markets in general. The recent market declines reinforce our ongoing commitment to providing diversified and asset allocated portfolios to our clients. Every market cycle has corrections, and having a diversified portfolio helps to reduce some of the volatility from equities during such periods. If you have experienced a change in financial circumstances or goals, or if you are concerned about the recent volatility, then please contact your relationship manager for a discussion.

Copyright 2018 REDW Stanley Financial Advisors, LLC. All Rights Reserved. This publication is intended for general informational purposes only and should not be construed as investment, financial, tax, or legal advice.