October’s Market Selloff
By Rich and Sheila Jamison
The most succinct description of recent market activity was a single sentence in last Friday’s Week in Review on Briefing.com.
“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.”
We felt that summed up October’s volatility rather well. If you’re like many other people, October’s market sell-offs made you nervous. Moreover, they’ve dropped most of the major indexes into negative territory for the year as of the October 26 close of business.
This certainly brought out the “this-market-has-been-bullish-for-too-long-and-now-it’s-over-and-the-bear-is-here” doomsayers again. Actually, they’ve been around for the last 3-4 years, emerging on every market drawdown. Someday, they will be right.
So, let’s examine the stock market history* (while recognizing that past performance cannot guarantee future results) that they may have overlooked:
- Corrections occur on average of every 357 days.
- Between 1945 and 2013, the average correction was 13.3% and lasted 71.6 trading days (14 calendar weeks).
- Predicting when corrections will occur regularly is impossible.
- Corrections do not matter unless you are a short-term trader.
- Corrections are an opportunity to buy high quality stocks at a bargain.
- Corrections are a reminder to reassess your holdings, rebalance your schedule and your overall plan for navigating volatile markets.
* Voya Global Perspectives, Doug Coté & Karyn Cavanaugh, October 26, 2018.
The point here is that corrections are not the usual cause of bear markets. Economic recessions are the primary cause of bear markets.
- Recessions are economic slowdowns
- Economic slowdowns hit company earnings
- Lower earnings hit stock prices
Friday’s advance look at Q3’s GDP showed us a +3.5%, both a solid and better-than-forecast number. It is not characteristic of economic troubles.
So, Why the Sell-off?
Apparently, the recent selloffs are not because of our economic activity. A 3.5% GDP is strong growth.
Further, the selloffs are not because of corporate earnings. They have been strong.
Many events – a “worry list” – have the potential to affect the future financial market. (By the way, this list is the stuff of news headlines, used to attract more eyeballs and sell more ads.) Recent selloffs appear to have come from worry about the future market impact of one or more of these items.
Current Worry List
- Political uncertainty (here and abroad)
- Increasing interest rates
- An inverted yield curve
- Increasing wages
- Tariff issues,
- A strong US dollar
- Raw material price hikes
- Higher transportation costs
- Increasing consumer goods prices
- Company profit margin pressures
- Slowing EU growth (Brexit & Italy spotlighted now)
- Slowing China growth
- Slowing emerging markets
- Diplomatic uncertainty
- Careless remarks by influential people
Worry lists have always existed. Some have been longer and others shorter than the one above. Items comprising them have mutated from one time to another. Still, there have always been causes for worry. (We’re sure you will think of another item or two we missed in our list. Please just add them to your considerations.)
The Common Thread
What worry list item have in common is that they can all bring pressure to bear on company activity – sales, pricing, productivity, profit margins – and, eventually, corporate earnings. Worry about future growth – of lack of it – appears to be top of mind for many investors during October’s selloffs.
The Earnings Story
As of last week, 47% of the constituents of the S&P 500 Index have reported for the third quarter. Blended earnings — analysts' estimates combined with reported earnings — are running at a 22.5% year-over-year pace of growth while revenue growth is running at 7.4% growth. Last week’s flurry of strong quarterly reports raised the growth rate more than 1% over the prior week's pace. It is up by 3.2% since September 30.
True, Q3’s numbers are running slightly behind Q2’s exceptionally strong 25% earnings per share growth rate and 10% revenue growth. However, Q3 is putting strong corporate results on the scoreboard.
When facing potential slowing future earnings, the forward 12-month EPS estimate is more important than historical earnings. The forward EPS has increased by 0.8% since October began, standing in opposition to lower future earnings expectations.
Moreover, the market pullback has strengthened corporate earnings from a different viewpoint. While earnings grew, stock prices fell. The 12-month forward Price/Earnings (P/E) ratio has been compressed. It was 16.8 when October began. It is now 15.5.
Many analysts and investors use the P/E ratio to judge when to buy and when to sell. Buy when the P/E is lower and sell when it is higher. (We don’t always agree with them, but it can sometimes be a useful indicator when used judiciously.) How’s this working out in October?
Investors had become accustomed to seeing stocks bought on weakness over the last few years. Every pullback was quickly recovered by buyers coming into the market and picking up ‘bargain-priced’ stocks.
During October selloffs, buyers haven’t been jumping in – at least, yet. This appears to have shaken investor confidence and further contributed to selling efforts. The relevant behavioral finance tenet is the Recency Bias; weighing recent history more heavily than longer-term history.
For example, the S&P 500 is still up nearly 300% from its low and the beginning of this long bull market in March 2009. Nevertheless, recent selloffs of key leadership stocks and groups (i.e. Alphabet, Amazon, Facebook, communication services, consumer discretionary, financials, industrials and technology) have upset the balance of confidence. Rallies have been viewed as selling opportunities instead of buying opportunities.
It was another terrible, horrible, no-good, very bad week for a stock market. The selloffs appear to be driven by earnings growth concerns, not by either actual earnings or economic growth.
We’re constantly reassessing, diligently watching our preferred indicators and listening to the market to see which way it says it really wants to go. We aren’t throwing in the towel yet. We are ready to move when the market tells us it’s time.
As always, we’re here to talk with you if you have specific concerns or questions. We also suggest you pass along this article to any nervous friends, relatives and colleagues who might benefit from reading it.
Nothing in the above is meant to be, nor should it be construed as, investment advice or recommendations to buy or sell any security. Individual securities, whenever mentioned, are for illustrative purposes only and may not be relied upon as investment advice.
All indices are unmanaged and are not illustrative of any particular investment. A direct investment cannot be made in any index.
Tax and/or legal information contained herein is general in nature and for informational purposes only. It should not be relied upon as advice. Consult your tax professional or attorney regarding your unique situation.
Past performance is no guarantee of future results.