For equity investors, October is a month that is met with some trepidation. It is often referred to as the “crash” or “jinx” month, with pronounced weakness or crashes happening in 1929, 1987, the 554-point drop on a single day in October 1997, back-to-back massacres in 1978 and 1979, Friday the 13th in 1989, and the meltdown in the heart of the Global Financial Crisis (GFC) in October 2008. From just that limited list, one might be surprised to learn that October is in the middle of the pack (ranked seventh) in terms of the S&P 500’s monthly performance. In fact, the market has turned the tide in 12 post-World War II bear markets occurring in October, including most recently in 2011.
Over the course of Wednesday, October 10th and Thursday, October 11th of this year, the Dow Jones Industrial Average and S&P 500 Index dropped more than 5%, capping a period of six consecutive days of losses—the longest such stretch since November 2016. The S&P 500 followed that with another six-day losing streak, punctuated by an 85-point decline (3.1%) on October 24th. At the close on October 24th, the Dow had turned slightly negative for calendar-year 2018, while the S&P 500 flirted with negative territory.
Technology stocks, which have been a significant driver behind U.S. equity market returns over the past several years, have added to the malaise, as both the S&P 500’s technology sector and the tech-heavy NASDAQ index have been among the worst performers, down 9% and 10%, respectively. Recent market leaders and “darlings” as represented by the NYSE FANG+ Index (Facebook, Apple, Amazon, Netflix and Alphabet’s Google) were down over 13.5% at the month’s lows.
Wednesday’s headline loss of 608 points for the Dow Jones Industrial Average is eye-opening and to the casual observer would be a cause for concern. And while such a move is notable, as the markets have marched steadily higher since the GFC, percentage declines have translated into larger absolute point declines than when the indices were at lower levels. The 608-point decline was the 14th-largest point decline in history but doesn’t make the top 20 in terms of percentage declines.
Two more points are worth making to provide some context. First, the single-worst day in stock market history was “only” a 508-point decline on Black Monday, October 19, 1987. That represented a single-day loss of 22.6%, showing again that as the markets climb higher, absolute changes will become larger accordingly. Second is that as this is being written (the day after the carnage), stocks have rebounded and the Dow and S&P 500 are both slightly higher for the calendar year—despite the fact that eight of the 20 largest point declines on record for the Dow have occurred in 2018.
What is behind the recent weakness in equities? First, corrections and volatility are normal. A correction (defined as a decline of 10%) has happened on average once every two years since 1968, and Deutsche Bank suggests that over the very long term, corrections have happened on average once a year. In order to realize the higher potential returns of equities, one must be willing to accept the accompanying volatility.
In this most recent timeframe we would suggest that the market is being bothered by a combination of:
• Concerns over trade and tariffs and the uncertainty that recent actions and rhetoric have created.
• Tighter financial conditions – This is a combination of higher short-term interest rates, the U.S. Federal Reserve’s ongoing balance sheet reduction, the stronger dollar and ongoing trade tensions.
• Political polarization – One can argue that the decline in polarization surrounding World War II and the unifying effect of the Cold War and the fight against communism in the latter half of the last century were outliers and that polarization is more normal through history. Polarization isn’t necessarily bad if it results in stable policies as a result of gridlock. The recent large political demonstrations and the bomb mailings as well as the underlying tone of violence saps confidence and creates the possibility of less stable conditions, which financial markets historically haven’t liked.
• Elevated valuations relative to history, although not necessarily to other investment options (most notably bonds).
Despite these concerns it is important to remind ourselves of what is going well. Overall, the economy remains on very solid footing with low unemployment, stronger growth as measured by GDP, strong earnings, and strong business and consumer confidence. It is also important to note that market declines independent of a recession tend, historically, to be relatively short-lived, and the period following midterm elections tends to be strong as uncertainty fades.
Acknowledging that recent performance has increased investor anxiety we would remind investors to:
1) Keep perspective and understand that corrections happen and, while uncomfortable, are relatively normal.
2) Expect volatility to continue after a period of abnormally low volatility.
3) Review long-term plans to ensure they are consistent with individual risk tolerances.
While no one knows what will happen next, the strength of earnings and the overall economy suggest that conditions are still supportive for equities despite current valuations.
By Bill Hornbarger, Moneta CIO