No Black Monday deja vu

10-19-2018

Bottom Line Mark Twain famously wrote that October is one of the “peculiarly dangerous months” in which to speculate in stocks. The brutal memories of crashes in 1987 and 1929 haunt investors as we approach Halloween each year. Today’s 31st anniversary of Black Monday, the stock market’s largest one-day percentage loss in history, still elicits a spine-tingling chill for investors. That’s when the Dow Jones lost 508 points, erasing 22.6% of the index’s market value. Today, the Dow would need to plummet more than 5,700 points to equate that collapse. It’s a daunting prospect, but also a risk we believe is unsupported due to strong economic and corporate-profit fundamentals and attractive valuation levels.

That hasn’t stopped the perma-bears from growling over the past two months, however, as financial markets were reeling. The small-cap Russell 2000 plummeted 12% since Aug. 31 to last week’s bottom, the S&P 500 corrected nearly 8% from mid-September, and benchmark 10-year Treasury yields soared from 2.80% in late August to a 7-year high of 3.25%. Those indexes appeared oversold, while the volatility index (VIX) nearly tripled in a week to an overbought 29.

In our view, several headwinds contributed to these conditions, including: the fear of a monetary policy error by the Federal Reserve; President Trump’s growing trade and tariff war with China; a stronger U.S. dollar; rising oil prices; and the potential fiscal-policy impact from a “Blue Wave” in the midterm elections.

But there are three potential catalysts on the immediate horizon that we believe could reverse this stock market correction, prompting us to put some dry powder to work back into equities at more attractive prices. We’re roughly 15-20% into another solid earnings season, as third-quarter earnings per share are up 21% year-over-year, with three-quarters of S&P companies beating consensus expectations nearly 4%. Next, third-quarter GDP will be flashed Oct. 26, and we’re expecting a strong 3.5%. Finally, the midterm elections will be held on Nov. 6, and we’re expecting a less-bad-than-feared outcome.

In addition, underlying fundamentals remain strong. The healthy labor market boasts a low unemployment rate (3.7%), a 49-year trough in initial weekly jobless claims, the fastest wage growth (2.9%) in nearly a decade and job openings at a record 7.136 million. There are a record 900,000 more job openings than unemployed Americans who can fill them. Consequently, consumer spending during the Back-to-School (BTS) months of July through September rose 5.9%, its strongest pace in seven years. Also, various business and consumer confidence metrics are at multi-decade cycle highs.

October is the month that bear markets typically go to die, and we don’t expect this year to be any different. As a result, we remain confident the S&P will hit our year-end target of 3,100, which implies solid double-digit appreciation potential from here.

Increasing our GDP forecast The fixed-income and equity investment professionals who comprise Federated’s macroeconomic policy committee met on Wednesday to discuss the strong economy amid the challenging backdrop of choppy financial markets:

• Second-quarter GDP was unrevised at a final gain of 4.2% versus 2.2% in the first quarter.
• With a strong labor market, elevated business and consumer confidence, and solid consumer spending and manufacturing activity, we are moving our third quarter GDP estimate up a tick from 3.4% to 3.5%, while the Blue Chip consensus is raising its estimate from 3.1% to 3.3% (within a range of 2.9% to 3.8%), the Bloomberg consensus is at 3.2% and the Atlanta Fed’s GDPNow model is at 4% (up from 3.8%). The Commerce Department will flash this report Friday.
• We expect a stimulative rebuilding program in the wake of Hurricanes Florence and Michael to begin in the fourth quarter. Also, the strong BTS season suggests that Christmas also may be strong, so we are raising our fourth quarter GDP estimate from 3.3% to 3.4%, while the Blue Chip consensus is unchanged at 2.8% (within a range of 2.3% to 3.3%).
• Our full-year 2018 GDP estimate is unchanged at 3%, while the Blue Chip consensus remains at 2.9% (within a tight range of 2.8% to 3%).
• Largely due to seasonal weather concerns, we are decreasing our first quarter of 2019 GDP estimate a tick from 2.9% to 2.8%, while the Blue Chip consensus moves its estimate down from 2.4% to 2.3% (within a range of 1.7% to 2.9%).
• We are raising our second quarter of 2019 GDP estimate from 3% to 3.1%, while the Blue Chip consensus remains at 2.5% (within a range of 1.8% to 3.1%).
• We are slightly reducing our third quarter of 2019 GDP estimate from 2.4% to 2.3%, while the Blue Chip consensus stands pat at 2.2% (within a range of 1.6% to 2.8%).
• We also are moving our fourth quarter of 2019 GDP estimate down a tick from 2.4% to 2.3%, while the Blue Chip consensus is unchanged at 2% (within a range of 1.1% to 2.6%).
• We are leaving our full-year 2019 GDP estimate at 3%, while the Blue Chip consensus also is unchanged at 2.6% (within a range of 2.1% to 3%).

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Disclosures:

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

Russell 2000? Index: Measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index. Investments cannot be made directly in an index.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

VIX: The ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility.

Federated Advisory Services Company