October 25, 2018 — Equity markets continue to exhibit significant selling pressure. Unlike the prior corrections in early 2016 and early 2018, the origin of this month’s rout in the stock markets is difficult to pin on any one factor. Instead, it seems to be due to a combination of a slight deterioration in the global growth outlook, concerns about peak earnings growth, and continued trade tensions. While all of these are valid concerns, the broad-based deterioration in equity markets far exceeds what we would think of as justified. As a result, global equity markets appear oversold, and this is increasingly looking like a technically driven correction.
While the markets are moving dramatically intraday, and it is difficult to ascertain what is prompting the swings, we would offer the following perspective:
- Economic data remain strong in the U.S., and we are forecasting the U.S. economy to finish the year strong with annual growth of 3%. We do expect a slowdown in 2019, but we still see little chance of a recession occurring within the next 12 months. U.S. corporate earnings have missed for some key companies, but we are still on pace for roughly 20% earnings growth versus last year.
- Non-U.S. economies have slowed, including China, but growth remains respectable. Chinese policymakers have also pledged support for private businesses and unleashed a series of stimulative measures, including personal tax cuts announced just this past weekend. The impact of these is difficult to estimate at this stage but could be meaningful.
- Volatility spikes outside of recessions are rarely a good time to sell. The 1-year return for the S&P 500 after a spike in volatility (defined as a one-standard deviation move in the CBOE Volatility Index) has been positive 86% of the time, for an average return of 19%. That increases to 93% if you exclude periods when we were in a recession.
- Major indexes have breached some significant technical trading levels this month, including the S&P 500’s 200-day moving average. This is likely triggering sell orders by computer-driven trading strategies, further adding to the sharp daily moves. The last time the 200-day moving average was broken on the downside by such a large amount was in early 2016. Similar to today, the market was panicking about slowing growth in China.
It is important to remember that volatility in markets is painful, but a normal part of investing. As of the close of markets on Wednesday, the S&P 500 was down -9.4% from its all-time high. For perspective, the index fell -12% at the beginning of 2016 and just over -10% in February of this year. On average, since 1980, the maximum pullback in the S&P 500 in any calendar year has been -14% (Figure 1). Even if we isolate those calendar years when the index posted a positive return, the average drawdown has been -11%.
Volatility in the stock market is normal. The key is not to overreact. We do not know how deep this pullback could go, but with valuations for U.S. equities back at levels last seen in early 2016, and no deterioration in our economic outlook, we are holding our ground, but remaining nimble as we receive incremental data from corporate earnings.
Figure 1: S&P 500 Calendar-Year Returns and Maximum Calendar-Year Drawdown
Data as of December 31, 2017.
Source: Bloomberg, WTIA.
Please join us for our Capital Perspectives conference call on Monday, October 29, 2018 at 2:00 PM EST. Our Chief Investment Officer, Tony Roth, and other members of our investment team’s senior leadership will address the recent market volatility, as well as, the upcoming midterm elections.
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