10/26/18 – Stocks. Ouch.

Stocks suffered another rough week with the Dow declining 3.0% while the S&P 500 decreased 3.9%. This continues a trend we’ve seen for most of October. Approximately 50% of companies in the S&P 500 are down 20%+ from their recent highs. Three-quarters of companies are down more than 10%. While the broader indices aren’t technically in a ‘correction’ yet by being down 10%, we touched correction level during intra-day trading today. So, what is going on here? The US economy continues to grow at an impressive clip – today’s report on 3rd quarter growth showed the economy grew at a 3.5% annualized rate in the quarter. The labor market is strong, wages are starting to grow, consumer confidence remains very high and corporate earnings have been strong. Those are all backward looking statistics though and investors are starting to worry about growth in 2019.

People are concerned about the Fed continuing to raise rates in the face of a slowing economy. I think the Fed will increase interest rates again in December, but that might be the end of the increases for a while. Trade war concerns remain elevated as well. There’s been minimal news on the trade front, but what markets would like to see are announcements of trade deals. Trump has been using the stick of tariffs to extract trade concessions, primarily from China, but no one really wants to see this turn into a protracted battle where tariffs damper global growth. I believe we’d see a sharp rebound in stocks if a China trade deal was announced. There’s also growing concern about the US debt and budget deficit. The deficit captures how much more the government spends annually than it collects in taxes. The debt is the cumulative total of years of deficits that have been paid for by borrowing money. With interest rates raising, we’re approaching a point where interest costs will consume a growing portion of our budget each year. There’s nothing wrong with running a deficit as long as the deficit as a percentage of Gross Domestic Product is less than the GDP growth rate. Sadly, that hasn’t happened in over 10 years and is sharply moving in the wrong direction currently. All of these issues have been around for a few months, but markets woke up to them over the last few weeks.

What should we do? Corrections are a normal part of markets. We’ve had five corrections over the last 10 years where markets declined more than 10%. It normally takes several months to work through the correction and reach new highs, but can sometimes be a year or more. While these are never fun to experience, they are a part of investing. Markets go up and down and economies ebb and flow. I think we’re at, or approaching, a level where this sell-off feels over done. Even if the economy slows, a recession seems unlikely at this point. I’ve lightened some stock exposure over the last week to lock in some gains and reduce equity exposure, but overall, I think maintaining current asset allocation is the most prudent response, especially for long-term investors.

Oil decreased this week, declining 2.3% to close at $67.68/barrel. The yield on the 10-yr Treasury moved lower, closing at 3.08% from 3.19% last week. The average rate on a 30-yr fixed rate mortgage ticked higher to 4.86%, from 4.85% last week.

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