Octobers have been the most volatile month for the past fifty years, and it is no surprise that this October has been nothing but fiscally evaporative. Since February, worldwide equity markets have been undergoing big shakeouts for the past few trading sessions. On 11 October 2018, the S&P 500 closed out 3.77 standard deviations below its 50-day moving average, which is the most oversold reading for the index since August 2015 -- to put that in perspective, there has only be eighteen incidences of such studies since 1928. The catalysts for the selloff were a steep rise in bond yields, higher oil prices and escalating trade tensions between the U.S. and China. Of these, higher interest rates represented the greatest concern, with the 10-year Treasury yield reaching a seven-year high of 3.25%.
Interest rates are an important indicator of where investors believe economic growth is headed. In this sense, the recent run-up in long-term interest rates that has rattled the stock market this week is actually good news. The U.S. economy is fundamentally strong, perhaps as strong as any time in the past 50 years. Accordingly, one should expect a normalization of monetary policy from the Fed and an upward movement in rates.
This has been our expectation throughout 2018. Our original Outlook 2018 report (published in January) called for economic growth to rise to 4% in the second half of the year with the 10-year Treasury yield reaching 3.25%. Both of these forecasts have proven to be spot-on.
So, how should we respond to the recent volatility? First, we must recognize that sharp market selloffs are simply part of the investing process. Over the course of any given year, one would expect to see one or two market corrections. As stock prices move higher, occasional setbacks are normal. Not fun, but normal.
Second, we must stay focused on the fundamentals. Robust corporate earnings have been the foundation of our market thesis this year with profits surging about 25% year-over-year. U.S. businesses have been making significant investments in their operations and this "capex" spending will likely produce robust earnings going forward. The third quarter earnings season began this morning with a few of the big banks reporting compelling results. We expect many more strong reports in the coming weeks.
Lastly, we have seen significant headway relative to global trade deals this year. Progress with the Eurozone, South Korea, Mexico, and most recently Canada have demonstrated that contentious trade challenges can be successfully negotiated. While trade issues with China persist, we believe an acceptable agreement will be achieved this year.
In short, we do not see the latest downturn as foretelling a new recession, or the beginning of a bear market. Our outlook remains constructive as we look forward to 2019. A downturn in economic activity will eventually develop, however we are a long way from this happening and market corrections are simply opportunities to put additional capital to work.
