October 22 – October 26 Week in Review
The stock market had another bad week last week, with all the major averages suffering large losses, in what has become a very bad month. Just how bad has it been? The Russell 2000 is down 12.5% in October; the Nasdaq Composite is down 10.9%; the S&P 500 is down 8.8%; and the Dow Jones Industrial Average is down 6.7%.
What’s happened? The market is worried about growth. That might sound odd considering it was revealed last Friday that third quarter real GDP increased at an annual rate of 3.5%, yet it is the message that has resonated, loud and clear, in the stock market's price action.
There are various explanations regarding the causes of the stock market's correction. Ultimately, they all feed into the one thing that matters most for the stock market: earnings growth. The clearest evidence that the stock market is wrapped up in worries that future earnings growth won't live up to expectations is in the third quarter earnings results. They have been quite impressive. According to FactSet, the blended third quarter earnings growth rate is 22.5%, up from 19.3% on September 30. What's more is that the forward 12-month EPS estimate has increased by 0.8% over the same period.
Analysts, then, aren't marking down their estimates, yet investors are marking down stock prices sharply, believing those estimates are destined for a downward revision in due time as the effects of tariffs, higher interest rates, and higher operating costs kick in just as the initial thrust of the tax cuts gets kicked out and earnings comparisons become more difficult.
The quantitative result is that there has been a compression in the forward twelve-month P/E ratio to 15.5, versus 16.8, at the beginning of the fourth quarter, according to FactSet, as prices have dropped sharply while the earnings estimate has drifted higher. Even so, there hasn't been a concerted effort yet to buy into the weakness, which has been unsettling for investors who have grown accustomed to the stock market, and particularly the mega-cap growth stocks, always bouncing back in confident fashion.
The recognition that any strength has been viewed as an opportunity to sell has shaken investor confidence and has contributed to selling efforts on the part of investors trying to secure profits in popular trades before they disappear altogether.
That would take some time yet for anyone buying at the start of this bull market. The S&P 500 is still up nearly 300% from its low in March 2009; nevertheless, the ugly price action of late in key leadership stocks, key leadership groups, and the major indices has upset the balance of confidence in the stock market. That all came home to roost last week. There were some good reports to be sure and some encouraging reactions to those reports. Microsoft, Tesla, Twitter, Intel, and Boeing come to mind.
However, the stock market wasn't governed by their good news. It was governed by the disappointing guidance from the likes of Caterpillar, 3M, Texas Instruments, Amazon.com, Alphabet, Mohawk Industries, Colgate-Palmolive, and Western Digital to highlight a few examples.
Nothing cured the stock market last week, because none of its illnesses got cured. It is sounding like the trade war between the U.S. and China could be a prolonged one; Italy sounds as if it is thumbing its nose at the EU's request to revise its budget; Saudi Arabia's explanation for how Washington Post columnist Jamal Khashoggi died had obvious signs of being a cover up; Brexit negotiations have hit another impasse; the U.S. dollar strengthened; and, perhaps most importantly, Federal Reserve officials continued to make their case for why they think further rate hikes are warranted.
The latter is a central component of why the stock market is wrapped up in growth concerns. It is bothered by the idea that the Federal Reserve is going to raise rates too much, too soon, and choke off the U.S. economy's growth trajectory at a time when foreign economies, namely China and Europe, are already slowing down.
Again, though, that gets back to earnings growth concerns, which have fueled broad-based de-risking in the stock market. All 11 sectors in the S&P 500 ended lower last week. The real estate sector fared the best with a 1.0% decline while the energy sector fared the worst with a 7.1% decline.
There was nowhere to hide other than in cash and risk-free Treasuries. Yields fell across the curve. The 2-yr note came down 11 basis points to 2.81% and the 10-yr yield dropped 12 basis points to 3.08%.
The fact that the stock market found little comfort in the drop in market rates was a telltale sign that it was a terrible, horrible, no good, very bad week for a stock market caught up in a correction driven by earnings growth concerns.
Crude oil closed Friday at $67.62 down almost 3% from last week’s close.
October 29 – November 2 Economic Calendar