October’s stock swoon washed away much of this year’s price gains.
However, corporate profits posted their second-best growth rate in 10 years.
Democrats won control of the House of Representatives for the first time since 2010, and Republicans kept their power in the Senate.
- Share-buyback activity remains an important stock-market driver and could help lift prices.
- A divided Congress is unlikely to have a material effect on the market.
- Trade, earnings, and the direction of interest rates could be far more influential factors going forward.
Data Source: FactSet
The only good thing about October is that it’s over
October was the worst month for U.S. stock markets since September 2011. The S&P 500 Index lost 6.9% last month, while the Nasdaq and Russell 2000 Index each closed the month in a ‘correction’ (i.e., down 10% or more from their market tops).
During the month, the S&P 500 Index went 28 consecutive days without back-to-back days of positive returns — the longest streak since December 2015, according to research by Bespoke Investment Group.
Concerns over slowing profit growth, a revolt against technology stocks, and rising geopolitical tensions all put U.S. markets on the defensive. The combination of growing investor anxiety over rising interest rates and an entrenched trade dispute between the U.S. and China prompted investors to sell off both stocks and bonds.
Unfortunately, these issues do not have easy fixes. In our opinion, they are market factors that could play a prominent role in determining asset prices through the rest of the year and into 2019.
Americans have spoken, and they prefer a divided Congress
Following the most expensive U.S. Congressional mid-term election in history, America now has a divided Congress. We believe a Democratic-controlled House could stall Republican agenda items and force President Trump to turn outward towards foreign policy initiatives. It is also unlikely there will be much if any, meaningful change to the current tax and regulatory landscape over the next two years. As a result, markets may be content with a stalemate in the Capitol.
Sectors such as industrials, materials, and energy could benefit from a potential infrastructure bill, while the health care sector is likely protected for the time being from any major changes to the Affordable Care Act. However, we believe it will be a tall order for Democrats and Republicans to find common ground on any major issues over the next two years.
Though not front-and-center now, the federal budget deficit is projected to exceed $1 trillion in fiscal year 2019, at the same time the debt ceiling will need to be addressed later next year. According to estimates from the Congressional Budget Office, interest payments on U.S. debt could reach $390 billion next year — up 50% from 2017. The state of America’s finances will be on full display and could be a highly contentious issue in a divided government.
According to BCA Research, U.S. stocks historically move higher following the mid-terms, but post-election rallies tend to stall within six months when results produce a divided government. From our perspective, market cross-currents on trade, earnings and the direction of interest rates are likely to overshadow Washington politics.
In our view, October’s correction helped recalibrate expectations and asset prices to the reality of the current environment — which can be healthy for markets longer-term. Importantly, the economy and corporate fundamentals sit on a firm foundation heading into next year.
In our opinion, stock valuations are more attractive following recent weakness, and may finally offer the buying opportunity investors have craved since late spring. Positive seasonality factors and any constructive developments on trade could lift sentiment and equity prices through year-end.
With third quarter earnings season now in the rearview mirror, the mid-term elections over, and a potentially strong holiday shopping season on the horizon, there are reasons to stay positive.
Our advice to investors: View the stock and bond markets with a degree of caution and dollar-cost average into investments to put more money to work, particularly if stock prices decline further. If you are uncomfortable employing such a strategy, speak to your advisor about how you can ensure your portfolio is well-diversified based on your unique risk and time horizon.
The investment environment is changing. Although market fundamentals are supportive for asset prices, 2019 could pose challenges that test investors’ fortitude and appetite for risk.
As of November 15, 2018
Data source: Morningstar Direct