December 10, 2018

Stocks sank at the open again this morning. The Dow is currently off 367 pts and the SPX is down 1.25%. Energy and financials are worst-performing, down over 2.5%. Even the more defensive utilities sector is down nearly 1%. The VIX Index, a gauge of fear among traders, is up around 25, matching late October levels. WTI crude oil is down 2% to trade around $51.50/barrel. Most other commodities are down on the day and the dollar is stronger. Bonds are trading flat to slightly higher.

Today, the S&P 500 Index (SPX) broke through its October 29 intraday correction lows. Looking back, the index is down 11.8% from its October 3rd peak. And it seems likely to retest its February correction lows very soon. That level is only about 1.8% lower from here. Damage has been worse for small-caps, technology, and commodity producers. Those groups are down 12-15%. Today, some major brokerage houses are characterizing the market as oversold, primarily because the economy is humming along quite well. JP Morgan analysts believe the risk of an economic recession is “overpriced.” Goldman Sachs’ David Kostin says stocks have traded down to a level implying zero economic growth next year, whereas economists generally forecast about 2.5% growth. This divergence between economic conditions and stock prices has created a buying opportunity.

Hyperbole is in the air, especially if you’re watching CNBC or Fox Business News. Even the normally level-headed Bloomberg is getting in on the action. An article today notes, “the S&P 500 is mired in its second correction of the year and poised for its worst annual performance since the bull market started in 2009.” We’re being told this, that, and the other thing are the worst since the Great Recession, blah blah blah. Nevermind that the 15% correction in late 2015 and early 2016 that was brought about by some pretty daunting risk factors: oil falling to $26/barrel; the first debt ceiling fight between congress & the president; Greek debt default; Chinese stock market down 40% due to economic growth concerns; US corporate profits shrinking due to slower global economic growth and deflation. Oh, and of course, let’s ignore the 20% stock market correction we suffered through in 2011. In my view, those two events were more menacing and potentially dangerous than the current correction.

We all know that the stock market fluctuates in order to take into account (or “discount”) future expectations for the economy and corporate profits. And over the last several months the outlook has clearly become more murky. How far will the Federal Reserve take interest rates? How far will President Trump push the trade conflict with China? These questions are unanswerable, and so we get cheaper stock valuations. The price-earnings (P/E) ratio on the SPX has fallen to 15.9 from 20 at the beginning of the year. Risk is being “priced-in.” Mr. Kostin’s point is that the pendulum has probably swung too far. Further deterioration in stock prices only makes sense if corporate profits and economic growth are grossly overestimated for 2019. And there just isn’t much evidence to suggest that will be the case.

Qualcomm (QCOM) says a Chinese court ruled in its favor in a patent suit against Apple (AAPL), (Bloomberg). The court has apparently ordered an import & sales ban on most iPhone models in China. Apple acknowledged the ruling, but says it only affects devices using its iOS 11. Current devices use iOS 12. Apple also says the ban went too far—in other words the court overstepped. Apple also says it is still selling all iPhone models in China. So there is some confusion here. The stock is down 2% today, mostly because investors are worried that the Chinese Communist Party may decide to outlaw its products in retaliation for US trade tariffs.

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