Second, the earnings season is shaping up to be a mediocre one. As of Friday, third-quarter earnings are down around 2%. While that is in line with expectations, if it continues it will mark the end of 11 quarters of earnings growth. In addition, only 42% of companies in the S&P 500 have reported sales above estimates. While gross domestic product growth did accelerate in the third quarter–from an anemic 1.3% in the second quarter to a more respectable 2%–the recovery is not really strong enough to generate much revenue growth.
And as we get closer to the election, we’re seeing some reluctance to commit new capital to the markets. With the polls tightening in both the race for the White House and the Senate, there is growing uncertainty about the shape of the government in 2013 and how this might impact markets. A continuation of divided government will make it more difficult to negotiate a compromise over the fiscal cliff, the risks associated with the tax hikes and spending cuts scheduled to hit on January 1. If the election produces a clear sweep by one party, this will make it more likely that the fiscal cliff can be avoided and will take some pressure off stocks.
In the absence of a clear outcome, we believe volatility is likely to rise further. We’ve already seen the VIX index – which is often referred to as the “fear gauge” — increase from a multi-year low of 13 in August to nearly 20 last week. [Volatility ETFs]
In this type of environment, we would emphasize some of our all-weather themes such as:
- Municipals, like the iShares S&P National AMT-Free Municipal Bond Fund (NYSEArca: MUB);
- US minimum volatility, like the iShares MSCI USA Minimum Volatility Index Fund (NYSEArca: USMV); and
- International equity exposure, like the iShares MSCI ACWI ex US Index Fund (NasdaqGM: ACWX). Since the start of October, international stocks have outperformed the United States.
Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist.
