Volatility Uncovers Opportunity

by Catherine Trinder Miller, October 10, 2018

While sharp movements in financial markets can be unsettling, history demonstrates that equity markets don’t move up in a straight line. Price corrections are healthy as periodic pullbacks reset valuation to more reasonable levels. This can be viewed as opportunity for long-term investors.

Financial markets are complex, yet we can reflect on the interaction of three economic variables to explain sharp price movements like we had today: Growth, Interest Rates, and Inflation.

In the past three weeks, as evidenced by the 10-year U.S. treasury bond, interest rates have moved higher faster than market participants expected. While the absolute rate at 3.22% is low relative to historical levels, and not yet restrictive in terms of borrowing costs, the pace of the adjustment was fast and came at a time when uncertainty around China/U.S. trade policy and the mid-term elections is high.

As financial market participants do not like surprises or uncertainty, the market reaction was sharp.

The silver lining is Growth. Corporate earnings growth and consumer spending have been strong this year, in part fueled by tax reform stimulus, including incentives to repatriate large corporate cash balances offshore, and reduced regulation. Sentiment has improved and corporate earnings growth has accelerated with the last two quarters showing an exceptional 27% year over year growth in each quarter, respectively.1 As third quarter corporate earnings reports begin in earnest next week, the expectation is that year over year earnings growth will continue in the 20%+ range.2

All the while, inflation, while gradually moving higher, remains reasonable relative to the Federal Reserve target of 2.0%.

Economic fundamentals are strong and U.S. equity market valuation, after today’s price movement, has reset to 15.6x 2019 expected earnings, a meaningful discount to the post World War II historical average of 16.7x.3 In historical terms, this is not an expensive market.

While near-term prospects for the economy remain strong, concerns about the November mid-term election and trade policy disruptions may fuel continued volatility. Investors with a diversified portfolio, properly positioned to help meet their specific needs and goals, should not fear market volatility. We remain vigilant in managing risks and seeking opportunities that volatile markets inevitably uncover.

1 S&P 500 earnings growth. Source: J.P. Morgan’s Guide to the Markets, 4Q18.
2 S&P 500 earnings growth. Source: Refinitiv S&P 500 Earnings Scorecard, 10/8/18.
3 U.S. equity markets are represented by the S&P 500. Source for 2019 expected earnings is Refinitiv analyst consensus earnings estimate. Source for post-World War II historical average multiple is Wharton’s Jeremy Siegel.

The information contained in this email does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Catherine Miller and Teri Benson and not necessarily those of Raymond James and are subject to change. Past performance is not an indication of future results and there is no assurance that any of the forecasts mentioned will occur. Investing involves risk and you may incur a profit or loss regardless of strategy selected. No investment strategy can guarantee success. The process of rebalancing may result in tax consequences. Economic and market conditions are subject to change. The Dow Jones Industrial Average is an unmanaged index of 30 widely held stocks. The NASDAQ Composite Index is an unmanaged index of all common stocks listed on the NASDAQ National Stock Market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary.

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