October 29, 2018

Stocks opened higher this morning. The Dow is currently up 105 pts and the SPX is up .7%. Utilities, consumer staples, materials, real estate, healthcare and financials are all up over 1% at the moment. Energy and consumer discretionary sectors are down slightly. The VIX Index, a measure of traders’ fear, fell back to 24 after spiking above 25 on Friday. European stock markets will close up over 1% and Asia was mixed overnight. China’s markets, however, are still under pressure. The Shanghai Composite Index is down over 28% this year in local currency terms. The dollar is a bit stronger today against a basket of foreign currencies, and up nearly 5% in 2018. Wall Streeters are increasingly concerned that a stronger dollar will hurt US businesses selling overseas. A few blue-chip companies have said so in recent days. Commodities are trading lower. WTI crude oil is down .6% to trade at $67.17/barrel. Bonds are selling off today after a pretty strong run over the last week or so. The 5-year and 10-year Treasury yields ticked up to 2.94% and 3.10%, respectively.

Let’s go through this market correction by the numbers. Since the S&P 500 Index (SPX) peaked on 10/3, it fell 10.6% at the lowest point on Friday 10/26. That’s very similar in magnitude to the January/February correction. The Nasdaq fell about 12.4% as growth & momentum stocks got hit worse than value. For instance, the S&P technology sector shed about 10% while more defensive sectors like utilities actually climbed a bit. Some technical damage was done; the SPX is now trading below its 50-day, 100-day and 200-day moving averages. It also broke a near-term support trendline. But the longer-term stock market uptrend is still intact. Obviously, the stock market is considerably cheaper than it was a couple of weeks ago. The forward P/E ratio on the SPX plunged from about 16.5 to 15.5. The last time the market traded so cheaply was early 2016 in the wake of oil shock correction. David Kostin, an equity strategist at Goldman Sachs, says the market is now over-sold and could see a 6% rebound into year-end. Morgan Stanley, on the other hand, thinks this selloff could morph into a bear market if the Federal Reserve continues to tighten monetary policy. So these diverging views, as well as shifting headlines, are why the market will likely continue this tug-o-war for a while longer.

A quick look at CNBC’s headlines last Friday showed that the news media is beginning to panic. Articles discussing “hiding out” in defensive stocks, or avoiding retiring in a “down market” were prominently placed. Here’s my favorite scare-tactic headline: “The Stock Market Loses 13% In a Correction On Average, If It Doesn’t Turn Into a Bear Market.” My favorite cheeky response to this building fear came from Barron’s: “S&P 500 Drops 3.9%--Is It Time to Panic?” In other words, are we really going to pretend that this kind of volatility doesn’t happen on a regular basis?

So far, about half of S&P 500 companies have reported third quarter results. About 82% of companies have beaten Wall Street expectations for profits, and about 58% have exceeded revenue forecasts. Analysts are struggling to sort out appropriate conclusions from company reports. It hasn’t been easy. Southwest Airlines (LUV) issued disappointing results driven by rising wage & fuel costs. Some tried to use this report as evidence that US corporate earnings are deteriorating. Others think this just represents industry-specific weakness. And while costs are rising, the demand for travel is still strong. Likewise, Texas instruments (TXN) issued a disappointing report primarily because it was exposed to the auto industry. Some tried to use the report to paint the entire semiconductor industry with negativity. On the other hand, we’ve all known that the auto industry has been weak, not to mention especially vulnerable to trade tariffs. So can you really translate this negativity to the entire industry? We heard the same debate after semiconductor firm Advanced Micro Devices (AMD) disappointed. But how can a weak report from AMD be considered a bad thing for the rest of the industry when competitor Intel (INTC) reported a great quarter?

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