Weekly Wire: Halloween is coming and the market is getting spooky (again)
How fitting. It’s October and just like Michael Myers in the Halloween movie, market volatility has returned to give us all a fright, with the S&P 500 Index (S&P 500) off nearly 4% at one point for the month.
We see recent volatility, beginning with the broad swings in August, as the result of an elevated market and elevated investor sentiment bumping up against evolving US monetary policy, US politics, trade uncertainty, and signs of an economic slowdown. Recall the S&P 500 made an all-time high on July 26 when it traded at 3,027 and came close to matching that high when it hit 3,022 on September 19. As risk assets move higher, investor optimism often does too, and investor sentiment is a contrarian indicator – meaning when investors become too optimistic, that is typically bearish for the market near-term and when investors become too pessimistic that is typically bullish for the market near-term. The market was poised for volatility into August and October. When the Federal Reserve (Fed) disappointed Wall Street by cutting interest rates just 25 basis points on July 31, the S&P 500 fell 200 points in early August. That disappointment helped invert the US 2-year/US 10-year section of the yield curve on August 14, and that recession signal knocked 100 points off the index. In late August, China announced tariffs on $75 billion of US goods and President Trump responded by ordering US companies to leave China and the market fell again. But as we entered September, the US/China trade discourse improved, the Fed cut rates again, the US 2-year/US 10-year section of the curve turned positive, and the market rallied. As the market hovered near an all-time high and September gave way to October, we were confronted with a contraction in US manufacturing, a slowing in US services, an impeachment inquiry, and news the US would put tariffs on $7.5 billion of European Union imports. As a result, the market tumbled. History may not repeat, but it certainly seems to rhyme!
Now that we understand what is driving volatility, how concerned should we be? Not very, at least not yet. While the US economy has slowed, we don’t believe a recession is imminent; housing continues to strengthen and the US consumer is on firm footing. While an impeachment inquiry may prove additive to volatility, we are a long way away from any pivot in fiscal policy. Finally, another rate cut or two from the Fed in 2019 will shore up the US economy, while the most important trade dynamic remains between the US and China, and that continues to improve. Unless the Fed steps away or the US/China relationship falters meaningfully, our outlook remains one of modest growth and a gradual move higher for US equities.