Rough month for global equity indices. Yet, we remain above the March lows. At which time the S&P 500 fell to 2,588. three percent beneath today's level. For now, the primary uptrend remains higher. Though pragmatic market observers must recognize that the trendline could be in jeopardy should this month end with lower lows.
This places investors in a waiting game. As we believe the current bout of volatility to be like the many others incurred throughout this bull market. Providing, in the end, to be a healthy, "Scare-all-the-weak-hands" correction. Separating the wheat from the chaff. So long as indices reverse course -- then the current fireworks simply set the stage for the next run higher. Just when such a move is least expected.
Of course, that just happens to be how Mr. Market operates. One minute? Your best friend. The next? A stone-cold killer.
These last 9.5 years, we've been here before. We've seen markets regain their equilibrium and resume climbing. Many of the most-punished stocks been the very tech concerns that led the charge higher. Those holding coveted positions within the burgeoning technological arenas in which they operate. Tech stocks, especially the FANGs, have borne the brunt of the recent punishment. Only natural. Given the astounding performances these stocks delivered in the years leading up to October.
We believe the current volatility will -- for now -- continue to shake weak-minded investors off the scent of further tech glory. But we also postulate that Mr. Market is simply scaring those who anticipated tech/FANG to continue to deliver a free ride. Especially those who arrived late to the party. Who purchased tech/FANG shares this year. Expecting to simply strap in for a stratospheric moonshot.
Mr. Market never permits such a laissez faire approach to the hallowed union of risk and return. And we suspect that once enough of the chaff has been separated from the wheat, select tech stocks will roar back with a vengeance. Especially those driving such world-changing technologies as artificial intelligence, big data, cloud storage, autonomous vehicles and virtual reality. Among others.
That in mind, patient investors must be willing to give such stocks a bit of additional leash. Because ultimately, they will reveal their intentions. Leading to one of three possibilities:
1) They'll pivot and head higher;
2) They'll continue lower as sector rotation sees capital move to other, lower-valuation areas of the market;
3) They'll enter a trading range (a multi-month consolidation) as capital inflows await valuation guidance and extends the current waiting game.
Despite all the ominous signs pervading the investment landscape, one can discern positive signs.
Consider that the recent tumult has served to recalibrate equity valuations. Leaving stocks markedly less expensive.
The S&P 500 began the year with a trailing 12-month P/E of 23x. Today, it sits at 18.7 times earnings. With every sector's P/E having fallen. Tech's is at 19.5x, down from 24.6. Financials are at 13.8x, down from 18.9x.
Moreover, investor sentiment remains bullish. But only because it's so bearish.
The American Association of Individual Investor's (AAII) bullish sentiment index is down in the 35 percent range. Way below the 60 percent range hit in January. Such low sentiment is a positive sign for contrarians. As bull markets tend to die on the wings of excessive optimism. Not when bearish sentiment prevails.
Q3 has seen a continuation of positive earnings growth. And year-over-year economic growth. While relatively low interest rates remain in place. As does high consumer confidence. All at a time when the Christmas shopping season could be just the catalyst for a near-term trendline reversal.
Where does such a potpourri of possibilities leave investors?
In an anxiety inducing waiting game. As uncomfortable as that may feel. Because equity indices haven't fallen beneath those moving averages that would incite an abrupt change in DEFCON status. Which is to say, things look bad. But remain in a place where they could quickly improve. Repeating a pattern that has played out multiple times these last 9.5 years.
If and when we believe a negative inflection point has been reached? Our team will proceed to become much more defensive. Should the situation worsen from there? We'll seek to leverage opportunities on the downside. As many of our trailing stops will have gone off. Leaving big cash positions to redeploy. For now, however, we've seen cash positions elevate as some trailing stops have been triggered. But mostly, it's an exercise in patient observation. Watching. And waiting.
Keep in mind that positive seasonality could kick in. As equities tend to do well after mid-term elections. And in the final 1.5 months of the year. Underscoring the need to be patient. To cautiously and objectively observe these markets. To see if today's gales subside and give way (yet again) to another upward trendline. Or, might the S&P 500 break below the 2,588 threshold. Forcing additional, incremental selling as we assume a more defensive posture. And prepare for further deterioration.
Till then? We'll tightly grip the wheel. Acting as pragmatically and knowledgeably as we can. Searching for bluer skies. And calmer seas.
In politics, the 2018 midterms? Officially on the books. Sort of. As some Senate and House races remain unsettled.
It was a rough evening for Republicans. Democrats seem to have gained around 35 seats in the House. Seven governorships. And over 330 state legislators.
For that, however, Republicans should be thankful. Because, as rough as it was? It could have been worse.
President Obama's first mid-term in 2010 saw Republicans picked up 63 House seats and 700 state legislative seats. Nor were such numbers out of the question for Democrats in the months leading into this month's contest. Only to see Republicans actually expand their Senate majority. Whereas Democrats lost six Senate seats in 2010.
For investors, the midterm outcome was that rarest of gifts. Allowing both parties to claim victory. Which can only mean... Gridlock. Which explains why the market rose with such fervor the following day. Realizing that a split legislature translates to little being done legislatively. Preventing the addition or rescission of the economic policies currently in place.
Remember, effective investors learn to view the larger political dynamic in a way that is both detached and objective. Drawing lessons from the results. And never allowing politics to interfere with otherwise sound investment decisions. Most assuredly, the political winds will often shift. Whereas our devotion to those we care about, and establishing the most effective financial foundations on their behalves, will remain a constant endeavor throughout our lives. So, we choose to fret over that which we can control. And observe and learn from the rest.
More on the election, and how we view the market consequences, below.
In the nation's capital, the IRS announced a 2019 policy which changes the means by which it accounts for inflation. The move undermines much of the value of the 2017 tax cuts by raising tax bills for most Americans. Simultaneously increasing government tax revenue by $133.5B over the next decade.
While such policy hurts over time, the current deficit has become a huge though usually ignored issue. One that must be addressed. Making it hard to argue with the rare display of fiscal responsibility. Of course, if government expenditures increase in correlation to the additional tax revenues, as opposed to a lower deficit? Then prudent taxpayers may need to rise and storm the ramparts. As D.C. will have proven itself incapable of tackling its most pressing issues. At the expense of its taxpaying constituents.
Overseas, French President Emmanuel Macron continues to consolidate his role as Europe's chief power broker following the ignominious conclusion to the reign of Germany's Angela Merkel. Who was forced to abandon that role following her party's thrashing in regional elections last month.
Australia said it would establish a development fund offering Pacific island nations more than two-billion dollars for infrastructure projects. A project intended to bolster U.S. economic and military cooperation. And provide a more assertive bulwark against China's regional ambitions as displayed by its "Belt and Road" initiative.
The euro zone economy has cooled in 2018. A trend that European economists forecast will be expedited in the coming years as global demand for the EU's products wanes, global growth slows, or trade tussles escalate.
In the energy patch, oil dropped to $61 a barrel. Marking a 20 percent decline from the October 3rd high of $76. And ending oil's longest bull run since 2008. Driven in part by the Trump administration's decision to soften punishing sanctions against Iran. And so bolstering global supply. Sending inventory prices lower.
Major indices finished down last week. The DJIA gained lost 2.22%. The S&P 500 fell 1.61%. The Nasdaq fell 2.15%. While small cap stocks lost 1.42%. 10-year Treasury bond yields fell 11 basis points to 3.07%. Gold closed at $1,221.84, up $11.99 per ounce, or 0.99%.