Capital market update: Global assets sell off, but forward view remains balanced
October 10, 2018
U.S. stocks have followed global stocks lower so far in October, declining by more than 5 percent since the S&P 500 achieved an all-time intraday high on September 21, 2018. While recent capital market movements have been acute, particularly during today’s trading session, we view the price action to be a reset within a generally favorable backdrop for asset returns. That said, we are paying close attention to movements within the lending and credit markets to determine if recent movements presage weaker prices ahead. However, at this point, we do not see indications to move away from our more balanced risk/reward perspective.
Today, the S&P 500 closed on its low levels of the trading session, closing down 3.3 percent and representing the worst daily performance since the weakness experienced in early February. Rising U.S. interest rates have received much of the blame, with 10-year U.S. Treasury yields touching 3.25 percent for the first time since 2011, an almost one-half of one percent increase since late August. Other contributors to the sell-off include midterm election uncertainty, high growth expectations heading into third quarter earnings season and weaker international economic readings.
Risks from rising credit costs, but underlying growth story still appears to be positive
In challenging markets such as these, we lean heavily on our investment process for guidance. We examine the trends and momentum in economic growth and inflation, as well as company fundamentals, price trends (often referred to as market technicals) and investor sentiment.
- Without question, the most significant variable we are assessing is access to credit and the cost of financing. The recent move higher in interest rates has caused some movement in mortgage rates, as well as in other parts of financing markets but, to date, we are not seeing overly stressed conditions.
- U.S. economic growth remains solid, with recent data, such as unemployment, indicating further improvements. However, we do see some emerging signs the recent acceleration in economic growth may be “past its peak” as we head into the end of the year.
- Domestic inflation data has also improved modestly, but the dearth of wage growth and weakness in food prices indicate the inflation story may be somewhat more modest over the coming quarters.
- Corporate earnings and sales growth has been robust through the second quarter, aided by the tax cuts’ tailwind. While growth is likely to remain solid, the emerging signs of slower economic momentum, as well as challenging year-over-year earnings comparisons, indicate some fundamental headwinds ahead.
- Technical price trends have been solid and this current correction has done little to undermine the broad positive trend in the S&P 500. That said, we are seeing some deterioration in price trends, particularly for smaller companies, which may be challenged by higher interest rates.
- Valuations levels have been elevated (a risk for markets) and investor sentiment (as measured by implied options volatility, which is how much investors pay to hedge stock market risks in the options market) has been somewhat complacent until the last couple of days.
Taken together, we maintain our balanced risk assessment. Sharp movements, like what occurred today, are significant in isolation, but volatility is a component of most “normal” market environments. Domestic equity investors have experienced only four trading days where the S&P 500 fell more than 2 percent since early February 2018, so movements like today feel out of place.
In our view, the risk/return portfolio opportunity is balanced
Stocks have become cheaper in the past few days, but bonds have also become more attractive as interest rates have risen. Investors should align portfolios with longer-term strategic target allocations in this environment. Within stocks, we maintain a slight preference for U.S. stocks relative to foreign stocks, reflecting the relatively better economic growth environment. In fixed income portfolios, rising rates and the relatively flat difference between shorter-and longer-maturity bonds leads us to prefer somewhat shorter maturities. While taking on additional credit or default risk in corporate or high yield bonds may seem attractive on a comparative yield basis, we think these bonds are fairly-to-fully priced relative to the inherent risks.
We encourage clients to be aware of what is going on but not to make emotional decisions based on price movements alone. We are here to help contextualize market movements within your longer-term plan and will continue to update you on our thoughts. As always, if we can provide additional perspective on your unique situation, please do not hesitate to let us know.
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This information represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. Any organizations mentioned in this commentary are not affiliated or associated with U.S. Bank in any way.
Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.
Past performance is no guarantee of future results. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general.
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Investment in debt securities typically decrease in value when interest rates rise. The risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher- rated securities.