November 10 2018 Market Update

Equities Falter in October – What’s Next?

After an expansive period of growth, equity markets sharply reversed course last month. The S&P 500 gave up $1.91 trillion in value for October 2018,^[1] falling 6.9% for the worst month since September 2011.^[2] Developed and emerging markets also fell on trade concerns, a strong dollar, and slowing economic growth forecasts.^[3]

Of course, for many Americans this was simply a backdrop to the highly anticipated and hotly contested midterm elections on November 6^th. In other words, it’s been a newsworthy 40 days. What does it mean for you?

Choppy Markets Worldwide

International equities also had a tough month this October.

The Shanghai Composite fell 7.7% for the month on continued trade tensions, putting losses as over 30% for the year.^[4] Emerging and European markets also fell in October, with the MSCI Europe Index falling 5.31%^[5] and the MSCI Emerging Markets Index tumbling 8.71%.^[6]

Whether October reflects a short-term correction or part of a longer-term shift remains to be seen: as of now, forecasts are mixed. However, between interest rate increases by the Federal Reserve, a hardening of trade restrictions, and a strong dollar, there are some indications that economic growth will be more modest going forward.

The International Monetary Fund revised its global growth estimates down slightly on these factors,^[7] while corporate earnings – though still robust by any measure – have slowed compared to their phenomenal performance earlier in the year.^[8]

It would not surprise us to see some moderation in economic and earnings growth rates going forward: it’s difficult for us to imagine that the level of momentum we saw in 2017 and 2018 could be maintained indefinitely.

Rising Interest Rates: A Sea Change for Bonds?

One trend that appears to be moving relatively predictably is the rise in interest rates. The Federal Reserve has pursued a strategy of steadily raising rates in the face of strong economic and jobs reports, and the expectation is that this will continue, with Federal Reserve Chairman Jerome Powell calling for rates to “very gradually” move back to “normal.”^[9]

As of the third quarter, unemployment is at 3.7%^[10] and indications are that overall employment and wages are rising. The unemployment is currently at its lowest level since 1969; and it has been suggested that labor shortages could possibly hinder future economic growth.^[11]

For investors, rising interest rates implies higher yields on bonds – as market interest rates rise, bond yields do, too. This isn’t strictly “good” or “bad” news: it depends on your perspective. Higher interest rates mean that debt becomes more expensive for consumers, businesses, and the government. But it can also attract yield-seeking investors away from riskier assets, meaning higher demand for bonds as an investment, and higher returns for bondholders.

We’ll talk about this trend with you personally in the context of your portfolio, including how rising rates could potentially influence your personal investment outcomes and risk profile.

Midterm Elections

Finally, we had the long-awaited midterm elections on November 6. Democrats claimed control of the House of Representatives, while the Senate remains majority Republican.^[12] As of this writing, seven governorships officially passed to Democratic candidates and three states had yet to confirm outcomes.^[13] 

What it All Means

With a split legislature, we anticipate see more political gridlock going forward unless the parties begin making moves to reach across the aisle. For most people that sounds like a potential negative, but markets responded positively to the news. European markets, the S&P 500, and the DOW all posted gains on the day after the elections.^[14]

What happens next, however, is unclear. As noted, economic and corporate data remain strong, but we might not see the same momentum going forward. Combined with political and economic shifts both at home and abroad, we would not be surprised if volatility became a bigger factor in equity portfolios into 2019.

But, as you’ve heard us say time and again: this is the reason we believe in disciplined diversification. Markets go up and markets go down, and having a thoughtful strategy that works for you over time is, in our opinion, the most prudent way to navigate both times of plenty and times of turmoil.

Please give us a call if you’d like to discuss your allocations, and otherwise keep an eye out for more communications from us as we head into year-end.

JSF Financial