The Federal Reserve reaffirmed its commitment to higher short-term interest rates despite scant evidence of mounting inflation. The PCE Deflator rose just +0.1% in September (+2.0% YoY) while Core PCE was up +0.2% (+2.0% YoY). At the consumer level, prices rose just +0.1% (+2.3% YoY) while wholesale prices edged up +0.2% (+2.6% YoY). As has happened in the past, the Fed will likely hike until “something breaks” in an effort to ward off anticipated inflation. One could argue that they are currently meeting their dual mandate of full employment and stable prices (read 2% inflation target) and a pause is warranted. That would be most welcomed by equity markets.
U.S equities had their worst month in recent memory in October, with the benchmark S&P 500 Index shedding -6.84%, after rebounding by more than 100 S&P points to close the month. Small- and Mid-Cap equities fared worse, with the S&P 600 and S&P 400 Indices giving back -10.48% and -9.55%, respectively.
For the year, Large-Cap U.S. equities remain the top performers, up +3.01%, with Small-Caps close behind, up +2.54%. Mid-Caps on the other hand are down -2.77% year to date.
Equity market volatility returned in October, with the S&P 500/CBOE Volatility Index (VIX) rising +75.17% to close at an index level of 21.23; however, the VIX had spiked as high as 28.84 intra-month, before returning back to long term average levels. Volatility was likely driven by a confluence of factors (i.e. interest rates, politics, trade, earnings) rather than one single macro variable. Earnings season thus far has been solid, with estimates for year end 2018 S&P 500 EPS rising to $163.36. What’s more, 2019 earnings estimates remain elevated at $179.05, giving market participants pause that we may be nearing “peak earnings.” While we’re likely not at “peak” yet, the market sure has discounted that possibility (i.e. slower global growth, higher interest rates, etc.). Based on October’s monthly close of 2,712 on the S&P 500, the forward P/E multiple resides at 15.1x, which is down from 18.0x at the start of the year. Bottom line: while U.S. equities have been volatile (and will likely remain so) valuations are arguably more attractive than any other point this year (and recent memory for that matter).
From a factor standpoint, S&P 500 Value outperformed Growth during the market drawdown, falling -5.33% versus -8.08% for Growth. Growth names that have led the S&P 500’s march to all-time highs have lately become its achilles heel. Notably, Amazon closed the month off -20% from its all-time high of $2,050 after a mixed earnings report where EPS beat but growth rates slowed. Google, Netflix, NVIDIA are each down -15.16%, -27.97%, and -27.14%, respectively from their 52-week highs. Facebook reported a mixed quarter and Apple is on deck after today’s close. All eyes will be on Apple, still the largest company by market cap, for commentary on China, trade and tariffs. As a reminder, Large-Cap Technology companies remain a leadership group – both on the way up and on the way down. Stay tuned.