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Stocks plunge on rising interest rate and trade war fears

The intelligent investor is a realist who sells to optimists and buys from pessimists. – Benjamin Graham

The stock market continued its downward slide last week as fears of higher interest rates, rising bond yields and ongoing trade tensions between the U.S. and China took their toll. The Nasdaq Composite Index suffered the greatest amount of carnage as previously high-flying technology stocks such as the FAANGs (Facebook, Amazon, Apple, Netflix and Google) were the biggest losers. The broad stock market did not fare much better as the S&P 500 Index plunged over 4%, bringing losses in the month of October to 5%. The technology sector had been the best-performing sector of the market but many of these stocks had risen too far, too fast and were due for a pullback. Momentum was taking these stocks higher but their popularity among portfolio managers was what led to their downfall as their valuations became extreme relative to the overall market. Rising bond yields and fear of still higher interest rates down the road were the primary catalysts that sparked the selling. The yield on the 10-year Treasury hit 3.23%, the highest level in seven years, and the Federal Reserve seems intent on tightening monetary policy further by gradually raising the federal funds rate. Although President Trump criticized the Fed for raising interest rates, Chairman Jerome Powell will likely not be swayed by these remarks and will let future economic data dictate monetary policy. Another contributing factor to the stock market selloff last week was heightened trade tensions between the U.S. and China. There has been no progress on a trade agreement with China and prospects for a deal seem to be getting worse instead of better. The lone bright spot last week was the start of the third quarter earnings season, led by the banks. JP Morgan Chase, Citigroup, Wells Fargo and PNC Financial Services all reported strong earnings results. With third quarter profits expected to be nearly 20%, the stock market should be able to regain its footing and move higher.

Last Week

Inflation data was the focus last week and, for the most part, it was favorable. The September producer price index (PPI) rose modestly in line with expectations while the consumer price index (CPI) edged only slightly higher. In the 12 months through September, the CPI has increased 2.3%. While U.S. import prices rose more than expected in September due to higher energy prices, core import prices that exclude food and energy have risen only 1% in the 12 months through September. The University of Michigan consumer sentiment index in October remained near a 15-year high.

The International Monetary Fund (IMF) cut its global growth forecast for this year and next due to rising global trade tensions and higher oil prices.

For the week, the Dow Jones Industrial Average dropped 4.2% to close at 25,340 and the S&P 500 Index declined 4.1% to close at 2,767. The Nasdaq Composite Index fell 3.7% to close at 7,497.

This Week

Retail sales in September are expected to be much stronger than they were in August and leading economic indicators in September are also expected to be strong as prospects for the economy remain favorable. Both housing starts and existing home sales in September should be consistent with numbers reported last month. The Federal Open Market Committee (FOMC) releases minutes from its September policy meeting.

Financials will headline quarterly earnings reports again this week as Bank of America, Morgan Stanley, Goldman Sachs, American Express, Charles Schwab, U.S. Bancorp and Northern Trust are scheduled to report. Other notable companies on the agenda include IBM, UnitedHealth, Abbott Labs, Johnson & Johnson, CSX, Honeywell, Procter & Gamble, Philip Morris International and Schlumberger.

Portfolio Strategy

Mark Twain once said that October is one of the peculiarly dangerous months to speculate in stocks. While he went on to say that the other eleven months are equally dangerous, October was singled out. History does show that October can be a scary month in terms of steep stock market declines. But there also have been major rebounds from bear markets that have occurred in October and in mid-term election years, stock performance has been exceptional. History has also shown that equity performance has been excellent in the fourth quarter of a mid-term year and the first two quarters of a year that precedes a presidential election. More importantly, the fundamentals continue to be strong as third quarter earnings growth is expected to be about 20%. This could be the catalyst that the stock market needs to rebound from last weeks’ losses as long as companies also issue favorable guidance on earnings going forward. At the present time, consensus estimates for profits in 2019 call for 10% earnings growth, about half of the third quarter estimate but still above average. Whether or not this forecast proves to be accurate will depend largely on the effect of tariffs on inflation and the economy as well as how high interest rates rise.