The stock market had another terrible week, in what has been a very bad month. The Russell 2000 is down 12.5% in October; the Nasdaq Composite is down 10.9%; the S&P 500 is down 8.8%; and the Dow Jones Industrial Average is down 6.7%.
The thrust of matters is that the market is worried about growth. That might sound odd considering it was revealed on Friday that third quarter real GDP increased at an annual rate of 3.5%, yet it is the message that has resonated loud and clear in the stock market’s price action.
The worry isn’t about the growth that was just left behind, but rather the growth environment to come. Also, factor in a mid-term election year and no shortage of geopolitical concerns, and you have market chaos.
There are various explanations regarding the causes of the stock market’s correction: the adverse effect of a strong dollar; the slowdown in China and other foreign markets; tariff issues, raw material price increases; political uncertainty; diplomatic uncertainty; price increases for consumers; rising interest rates; and profit margin pressures.
Ultimately, they all feed into the one thing that matters most for the stock market: earnings growth.
The clearest evidence that the stock market is wrapped up in worries that future earnings growth won’t live up to expectations is in the third quarter earnings results. They have been quite impressive.
According to FactSet, the blended third quarter earnings growth rate is 22.5%, up from 19.3% on September 30. What’s more is that the forward 12-month EPS estimate has increased by 0.8% over the same period.
Analysts, then, aren’t marking down their estimates, yet investors are a little spooked. There hasn’t been a concerted effort yet to buy into the weakness, which has been unsettling for investors who have grown accustomed to the stock market, and particularly the mega-cap growth stocks, always bouncing back in confident fashion.
The recognition that any strength has been viewed as an opportunity to sell has shaken investor confidence and has contributed to selling efforts. It’s the “herd effect” and it could take some time to play out. It’s best not to get caught up in this rush for the door. Buyers will come back in at some point.
The S&P 500 is still up nearly 300% from its low in March 2009; nevertheless, the ugly price action of late in key leadership stocks (i.e. the FAANG stocks), key leadership groups (i.e. information technology, communication services, consumer discretionary, financials, and industrials), and the major indices has upset the balance of confidence in the stock market.
That all came home to roost in the week that just concluded.
There were some good reports to be sure and some encouraging reactions to those reports. Microsoft (MSFT), Tesla (TSLA), Twitter (TWTR), Intel (INTC), and Boeing (BA) come to mind.
However, the stock market wasn’t governed by their good news. It was governed by the disappointing guidance from the likes of Caterpillar (CAT), 3M (MMM), Texas Instruments (TXN), Amazon.com (AMZN), Alphabet (GOOG), Mohawk Industries (MHK), Colgate-Palmolive (CL), and Western Digital (WDC) to highlight a few examples.
On the international front, It is sounding like the trade war between the U.S. and China could take some time to work out; Italy sounds as if it is thumbing its nose at the EU’s request to revise its budget; Saudi Arabia’s explanation for how Washington Post columnist Jamal Khashoggi died had obvious signs of being a cover up; Brexit negotiations have hit another impasse; the U.S. dollar strengthened; and, perhaps most importantly, Federal Reserve officials continued to make their case for why they think further rate hikes are warranted.
The latter is a central component of why the stock market is wrapped up in growth concerns. It is bothered by the idea that the Federal Reserve is going to raise rates too much, too soon, and choke off the U.S. economy’s growth trajectory.
The translation heard from the lips of many pundits is that there is a fear of the Federal Reserve making a policy mistake.
Again, though, that gets back to earnings growth concerns, which have fueled broad-based de-risking in the stock market. All 11 sectors in the S&P 500 ended lower in the week just concluded. The real estate sector fared the best with a 1.0% decline while the energy sector fared the worst with a 7.1% decline.
Source: Briefing Investor