Linda S. Parenti, CFA
President & Chief Investment Strategist
It has certainly been a tough start to the month of October, which on average is a positive month for equities. The sharp drop in stock prices seen Wednesday and Thursday followed a string of modest down days, bringing the S&P 500 off 7% from its most recent high as of yesterday’s close. This morning, markets look to open decidedly positive, but as you know much can happen before the close today. Like many, you may be asking why has volatility spiked now and what is next?
Of course, pullbacks and corrections are a normal part of the rebalancing that occurs during an ongoing bull market. However, the last correction of slightly over 10% was in late February, so we may certainly be due. Numerous market commentators point to the Federal Reserve, suggesting their pace of rate hikes has become too fast, risking our economic growth. Since the Fed began their current path of normalizing rates in December 2015, there have been eight rate increases. Speculation is for another increase this December, especially if economic readings measuring inflation appear to be heating up. Inflation has been slowly rising, but so far has remained modest and is still hovering close to the Fed’s target.
Although interest rates have been rising, both the economy and stock market have been moving ahead all the while. At their current levels, interest rates are still historically low. Robust employment has led to high consumer confidence and is supporting consumer spending. This in turn has resulted in higher business confidence and investment of capital, boosted further by a lower tax burden. We are in a healthy economic period which should be able to withstand rates periodically going higher from these levels.
Wall Street also seems to have a growing anxiety regarding earnings and revenue growth as we start the third quarter reporting season. The fear is that the benefits of the tax cuts to earnings may be fading as well as the potential for lowered guidance from the impact of tariffs* on sales. Analysts had been lowering their expectations in recent weeks, which was negatively impacting stock prices. Third quarter revenues, earnings, and company guidance for future quarters will be important and closely watched. If economic activity remains solid, reports may now come in better than expected. Given the current pullback in prices, higher earnings would make equity valuations more attractive and lend confidence to the market.
* For more on trade and tariffs, see this month’s Market Insights contributed by my colleague, Neal Davis.
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Views and opinions expressed here are for informational and educational purposes only and may change at any time based on market or other conditions or may not come to pass. This material is not a solicitation to buy or sell securities and should not be considered specific legal, investment, or tax advice. The information provided does not consider the objectives, financial situation, or needs of any specific individual. All investments carry a degree of risk and there is no certainty that an investment will provide positive performance over any stated period. Equity investments are subject to company specific and market risks. Equities may decline in response to adverse company news, industry developments, or economic data. Fixed income securities are subject to market, credit, and interest rate risks. As interest rates rise, bond prices may fall. Past performance is no guarantee of future results.