Is the Past Week’s Market Volatility a Signal to Sell? [October, 2018]

During last week’s stock market sell-off, we saw a 5%, two-day drop in the S&P 500 index. But is this cause for long-term investor concern? A number of reasons have been stated as to cause and are discussed below.

The Economy is Overheating

1. As of June 30, growth is projected at 3% year over year but expected to fade in the last six months of 2019.
2. Unemployment is at historical lows, and future long-term growth will be labor constrained.
3. Since last week’s mini-correction, valuations are running below historical averages.

Conclusion: Any basis for a larger bear market is not readily apparent.

Inflation and the Fed

1. Inflation is running at 2.2% year over year. This is not scary.
2. Core CPI is 2.3%, and the Fed funds rate is 2.0-2.25%, implying a 0% real rate.
3. We still do not have real positive interest rates.
4. The neutral or equilibrium rate is estimated to be 3.5-4.0%, a rate that neither stimulates nor restrains economic growth.
5. Asset bubbles are the #1 threat to the economy. Past bubbles in technology, housing, and commodities were built on cheap money.
6. The best tools for fighting asset bubbles are higher interest rates and reducing financial leverage (borrowing).
7. The Fed’s pace of tightening is much slower than past moves. Proactively, the Fed needs to continue raising interest rates to deflate these pressures.

Conclusion: The problem is leverage (excess borrowing) and not inflation.

China

1. Chinese economic growth has slowed. Its historical 10% growth rate was not sustainable.
2. The current growth rate is estimated at 6%.
3. Chinese officials possess many fiscal tools for stimulus.

Conclusion: The Chinese economy is still solid and not headed for recession.

Tariffs

1. Corporations are quick to blame an external source in case earnings disappoint market expectations. Remember, 88% beat earnings guidance in the last reporting.

Conclusion: There is no notable impact on corporate earnings yet.

Final Thoughts

We agree with Dr. David Kelly, Chief Global Strategist at JP Morgan Asset Management, who best dubbed the past week’s turmoil as “A Tumble with-out a Theme.”¹ These facts alone should limit a market decline until more concrete evidence as to economic slowing becomes evident. Investors are advised to maintain discipline with their asset allocation strategy and to re-balance to target weights as appropriate.

Are you concerned about your investments? Feel free give us a call at 800-356-7666. We look forward to talking with you.