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Mixed Earnings and Economic Data Spark Higher Volatility

October 25, 2018

Stocks erased their gains for the year this week (Oct. 25) as investors reacted sharply to a small number of high-profile companies that reported lower-than-expected earnings. In addition, there are ongoing worries about slower global growth and the impact of higher interest rates. Although big daily moves (up and down) may seem unsettling, this month's pullback has put the S&P 500 down slightly less than 10% from its recent high – a return to normal market volatility following many months of tranquility. As frequently happens, bond prices rose as stock prices fell, reinforcing the stabilizing value of owning an appropriate mix of stocks and bonds based on your comfort with risk and long-term financial goals.

Despite a few negative headlines, corporate earnings are strong, up about 20% from last year. And while we think continued earnings growth can help markets stabilize and support a rebound in stock prices, higher volatility is likely to continue. Some details can provide a better perspective:

  • The earnings picture is mostly bright, but not without cracks – Corporate profits are on pace to grow by more than 20% this year, the strongest pace since 2010. Although announcements from Microsoft, McDonald's, Verizon and Procter & Gamble – as well as marketwide – have been quite strong, disappointments from 3M and Caterpillar on Tuesday (Oct. 23) and Texas Instruments on Wednesday (Oct. 24) soured the market's mood. Companies have cited tariffs and rising costs as headwinds, adding anxiety about higher inflation ahead, and the rising U.S. dollar has also reduced foreign earnings. Rising profits have improved valuations, making stocks more attractive in our view.
  • Global tensions continue – Last year's trend of synchronized global acceleration has faded, with slower growth in Europe and China. Recent data have signaled some stabilization in developed-market growth, while hopes for renewed policy stimulus in China may improve the prospects for emerging-market equities. These catalysts are likely to keep markets volatile, but they're counterbalanced by more stimulative monetary policies and more attractive valuations for global equities, supporting appropriate international equity allocations within diversified portfolios.
  • Rates aren't on a one-way trip – Fears of higher interest rates have been at the heart of recent stock market volatility. Rates retreated this week, with the 10-year U.S. Treasury yield dipping back to 3.10% versus its high last week of 3.23%. We don't think inflation will run hot enough to prompt the Federal Reserve to be more aggressive with rate hikes. That means rates should move gradually higher but not in a straight line, leaving sufficient breathing room for the economy and the equity bull market to progress.
  • Performance perspective – This volatility may feel more unsettling than it truly is, in large part because of how tranquil equity markets have been lately. Last year, the S&P 500 never experienced a drop larger than 2.8%, and leading up to this recent bout, the stock market had gone a remarkable 76 trading days without a 1% daily move. A wider perspective is important, however. The S&P 500 is down almost 10% from its all-time high but has still provided a total return of 5.9% over the past year and 28.9% over the past two years. Moreover, appropriate balance is demonstrating its value, as U.S. bonds are down less than 1% during this stock market pullback.

Market volatility over the past few weeks has brought emotions back into the market. Sizable daily fluctuations can be unsettling, but pullbacks are far less worrisome when put in the context of broader market performance. The outlook is more balanced in the later parts of the market cycle, but fundamentals are still sufficiently healthy to support this bull market. Don't be surprised by further swings in the stock market, and if appropriate, consider the opportunities created by short-term pullbacks.

Craig Fehr, CFA
Kate Warne, Ph.D., CFA
Investment Strategists

Important Information:

Past performance of the markets is not a guarantee of what will happen in the future.

Investing in equities involves risks. The value of your shares will fluctuate and you may lose principal. Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

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