Stocktoberfest 2018!! (A correction within a secular bull market)

October 30, 2018 | Vito Finucci


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What is happening with the stock market? Making sense of China, Oil, Italy and Trump in a rough October.

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Having gone from the single longest uninterrupted bull market run in US market history, with record low volatility, we get to October 2018 which is currently on track to be the worst since Feb. 2009.

 

Keeping things in perspective, as of Friday’s close:

  • The Canadian TSX is down about 6.00% for 2018
  • The S&P 500 Index, not including dividends, is down 0.56%
  • The S&P 500 Total Return (with dividends) is +0.98%
  • A 60/40 (TSX/Bond Index) split is down almost 4% (3.77%)

While bonds may have reduced volatility in portfolios in recent weeks they have NOT contributed positively to portfolios in 2018 so far. So, the only place to hide has been cash, yielding virtually zero.

 

We have been looking for a pullback for several months now, and while the last couple weeks have been painful, the short term has been nothing more than a correction back to the running bullish trend line.
 


        (Source: StockCharts.com)                    

 

The sharp recent rise in the 10-year US interest rate seems to get the bulk of the blame, but tariffs, trade wars, incidents in Saudi Arabia, a pending US mid-term election, Italian debt, among others have weighed in as well. Given most average years deal with a couple of 10-12% corrections, maybe we were simply due.

 

BUT! … as compared to those prior pullbacks there are several notable differences to point out:

  1. The Fed is raising rates vs. lowering or holding them
  2. The Fed is deleveraging its balance sheet (i.e. less QE)
  3. The current administration seems to be in a trade war with China
  4. The economic cycle is simply more mature
  5. Global central banks are also less stimulative
  6. Have earnings peaked?
  7. Volatility has picked up
  8. Many more I could add… but you get the idea
     

So that’s why we are greatly overweight cash in our discretionary portfolios for the time being.

 

Right now, we don’t see a recession in 2018 or the bulk of 2019, maybe in the back half of 2019, early 2020, which if true, should give us another 10-12 months of decent markets.

 

The current S&P 500 Price Earnings ratio stands at about 16.5x. This is not “cheap” but certainly not expensive either when the longer term average since the 1950’s has been 16x, but the 10-year Treasury yield averaged 5.6% and stands at 3.10% now. So at current levels it can be argued the S&P 500 remains “cheap”.

 

Concern about a trade war with China may have been the trigger for the recent decline as much as interest rates. The US imports about $500 billion from China, but only exports $130 billion worth to China. So any tariffs on Chinese goods only increase costs for both US corporations and consumers. I haven’t even mentioned their “borrowing” of US technical and intellectual property. Either way, my gut is that the US and China work out some form of a trade agreement in 2019.

 

Of course, there still remains the Italian financial situation, and the apparent murder of a Saudi journalist in Turkey and its potential impact on US/Saudi relations (and as an extension, on oil prices, the high level of debt throughout the global economic system, the breakdown of the market leaders (i.e. “FANG” names), the impact of algorithms on daily trading (now 60-90% of daily trading volume, up from 25% in 2004) all could have impact going forward.

 

The Fear/Greed Index has simply been crushed: 
 


That’s a good thing…

 

The US economy printed a +3.5% GDP number for Q3. That’s after two quarters of over 4% GDP.

 

Timing markets has proved to be nothing more than guesswork or pure luck in most cases. The chart shows the last 20 years why:

 


 

My gut is we need (in the next 2-3 weeks) to retest the lows seen earlier in 2018 in February, somewhere around 2600-2625 on the S&P 500, which means potentially another 4-5% to the downside. If we break that support and go harder lower, that would be a flag. If we hold there, I think November/December could be decent. Then the calendar flips into the last two years of a Presidential term which historically have been decent for markets as they try to “juice” the economy up for the next Presidential election in November 2020. We will see…
 

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Stay tuned,

 

Vito Finucci, B.COMM, CIM, FCSI

Vice President and Director, Portfolio Manager

 

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