While there were numerous theories behind the October sell-off in equities, weak economic data was not a culprit. Although perhaps softening a tad from earlier reports, by and large US economic data remains solid as evidenced by the third quarter’s 3.5% GDP growth rate.
Cyclical indicators such as the Markit US Manufacturing PMI and the ISM Manufacturing PMI (with readings of 55.6 and 59.8 respectively) both pointed to a steadily expanding US manufacturing base in September while the Markit US Composite PMI and the ISM Nonmanufacturing (54.8 and 61.6) were also strong (readings above 50 suggest expansion and below 50 contraction).
Despite the burgeoning trade war, rising US Dollar and higher short-term interest rates, corporate earnings remain solid with expectations for +25% YoY growth in bottom line EPS. Third quarter top-line revenues are expected to grow roughly +7.5% from the same period a year ago as the energy sector continues to recover.
With approximately half of S&P 500 companies having reported Q3 numbers, 75% have beaten earnings estimates while 56% have topped revenue forecasts.
A strong labor market continues to boost the US economy, elevating consumer confidence and spending. September’s 3.7% unemployment rate was the lowest reading in nearly 50 years. Third quarter Nonfarm Productivity came in at 2.2%, slightly beating estimates while Q3 Unit Labor Costs rose +1.2% versus estimates for a +1.0% gain. Average hourly earnings rose +2.8% YoY in September while Weekly Initial Jobless Claims (chart below) approached 200,000, a level not seen in years.
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.
This article was written by the team at Nottingham Advisors, a participant in the ETF Strategist Channel.