Weekly Expert Perspectives PAS

Growth Concerns Dominate in Very Bad Week for the Stock Market

The stock market just had another terrible, horrible, no good, very bad week, filling in some more blanks on what has been a terrible, horrible, no good, very bad month.

Just how bad has it been?  The Russell 2000 is down 12.5% in October; the Nasdaq Composite is down 10.9%; the S&P 500 is down 8.8%; and the Dow Jones Industrial Average is down 6.7%.

The thrust of matters is that the market is worried about growth.  That might sound odd considering it was revealed on Friday that third quarter real GDP increased at an annual rate of 3.5%, yet it is the sobering message that has resonated loud and clear in the stock market's price action.

The worry isn't about the growth that was just left behind.  Rather, it is about the growth to come -- or perhaps lack thereof.

There are various explanations regarding the causes of the stock market's correction: the adverse effect of a strong dollar; the slowdown in China and other foreign markets; tariff issues, raw material price increases; political uncertainty; diplomatic uncertainty; price increases for consumers; rising interest rates; and profit margin pressures.

Ultimately, they all feed into the one thing that matters most for the stock market: earnings growth.

The clearest evidence that the stock market is wrapped up in worries that future earnings growth won't live up to expectations is in the third quarter earnings results.  They have been quite impressive.

According to FactSet, the blended third quarter earnings growth rate is 22.5%, up from 19.3% on September 30.  What's more is that the forward 12-month EPS estimate has increased by 0.8% over the same period.

Analysts, then, aren't marking down their estimates, yet investors are marking down stock prices sharply, believing those estimates are destined for a downward revision in due time as the effects of tariffs, higher interest rates, and higher operating costs kick in just as the initial thrust of the tax cuts gets kicked out and earnings comparisons become more difficult.

The quantitative result is that there has been a compression in the forward twelve-month P/E ratio to 15.5, versus 16.8, at the beginning of the fourth quarter, according to FactSet, as prices have dropped sharply while the earnings estimate has drifted higher.

Even so, there hasn't been a concerted effort yet to buy into the weakness, which has been unsettling for investors who have grown accustomed to the stock market, and particularly the mega-cap growth stocks, always bouncing back in confident fashion.

The recognition that any strength has been viewed as an opportunity to sell has shaken investor confidence and has contributed to selling efforts on the part of investors trying to secure profits in crowded trades before they disappear altogether.

That would take some time yet for anyone buying at the start of this bull market.  To wit, the S&P 500 is still up nearly 300% from its low in March 2009; nevertheless, the ugly price action of late in key leadership stocks (i.e. the FAANG stocks), key leadership groups (i.e. information technology, communication services, consumer discretionary, financials, and industrials), and the major indices has upset the balance of confidence in the stock market.

That all came home to roost in the week that just concluded.

There were some good reports to be sure and some encouraging reactions to those reports.  Microsoft (MSFT), Tesla (TSLA), Twitter (TWTR), Intel (INTC), and Boeing (BA) come to mind.

However, the stock market wasn't governed by their good news.  It was governed by the disappointing guidance from the likes of Caterpillar (CAT), 3M (MMM), Texas Instruments (TXN), Amazon.com (AMZN), Alphabet (GOOG), Mohawk Industries (MHK), Colgate-Palmolive (CL), and Western Digital (WDC) to highlight a few examples.

Nothing cured the stock market this week, because none of its bugaboos got cured.

It is sounding like the trade war between the U.S. and China could be a prolonged one; Italy sounds as if it is thumbing its nose at the EU's request to revise its budget; Saudi Arabia's explanation for how Washington Post columnist Jamal Khashoggi died had obvious signs of being a cover up; Brexit negotiations have hit another impasse; the U.S. dollar strengthened; and, perhaps most importantly, Federal Reserve officials continued to make their case for why they think further rate hikes are warranted.

The latter is a central component of why the stock market is wrapped up in growth concerns.  It is bothered by the idea that the Federal Reserve is going to raise rates too much, too soon, and choke off the U.S. economy's growth trajectory at a time when foreign economies, namely China and Europe, are already slowing down.

The translation heard from the lips of many pundits is that there is a fear of the Federal Reserve making a policy mistake.

Again, though, that gets back to earnings growth concerns, which have fueled broad-based de-risking in the stock market.  All 11 sectors in the S&P 500 ended lower in the week just concluded.  The real estate sector fared the best with a 1.0% decline while the energy sector fared the worst with a 7.1% decline.

There was nowhere to hide other than in cash and risk-free Treasuries.  Yields fell across the curve. The 2-yr note came down 11 basis points to 2.81% and the 10-yr yield dropped 12 basis points to 3.08%.

The fact that the stock market found little comfort in the drop in market rates was a telltale sign that it was a terrible, horrible, no good, very bad week for a stock market caught up in a correction driven by earnings growth concerns.

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S&P 500 Index is a market index generally considered representative of the stock market as a whole. The index focuses on the large-cap segment of the U.S. equities market. Indices are unmanaged and one cannot invest directly in an index. Each company’s security affects the index in proportion to its market value. NASDAQ Composite Index is a market value-weighted index that measures all NASDAQ domestic and non-U.S. based common stocks listed on the NASDAQ stock market. Dow Jones Industrial Average is a widely-used indicator of the overall condition of the stock market, a price-weighted average of 30 actively traded blue chip stocks, primarily industrials, but also includes financial, leisure and other service oriented firms. Data and rates used were indicative of market conditions as of the date shown and compiled by briefing.com. Opinions, estimates, forecasts, and statements of financial market trends are based on current market conditions and are subject to change without notice. References to specific securities, asset classes and financial markets are for illustrative purposes only and do not constitute a solicitation, offer, or recommendation to purchase or sell a security. Past performance is not a guarantee of future results. Russell 2000 Index measures the performance of the smallest 2,000 companies in the Russell 3000 Index of the 3,000 largest U.S. companies in terms of market capitalization. MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Chicago Board Options Exchange Volatility Index (VIX) tracks the expected volatility in the S&P 500 Index over the next 30 days. A higher number indicates greater volatility.

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2018-69125 (Exp 1/19)

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