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October Market Sell-Off

October 12, 2018

Volatility has returned to the market for the first time since the January-March 2018 period with a 6.71% sell-off for the month of October on the S&P 500 Index.

 

 

Amidst that backdrop, the Federal Reserve raised interest rates yet again in September with a 0.25% hike to the Federal Funds Target Rate Upper Bound now at 2.25% from 2.00%. Furthermore, the Trump Administration's protectionist trade policy is threatening American multinational sales and exports as trade partners retaliate against tariffs. We believe the potential for a protracted trade war in a rising interest rate environment could be a catalyst for the current sell-off. The bull market, however, remains intact. The 14-day relative strength index is signaling oversold market conditions which could present a buying opportunity. 

 

 

We still see a sustained economic expansion in progress. The Conference Board Leading Economic Index continues to trend higher. We believe these strong economic fundamentals provide a floor to the stock market and a catalyst for a reciprocally strong market rebound. 

 

 

An inverted Treasury yield curve is often seen as a predictor of future recessions by about 1-2 years by our estimate especially when the 10-year Treasury bond yield is lower than the 2-year Treasury bond yield. We see a flattening Treasury yield curve, however, we have not yet seen an inverted Treasury yield curve occur just yet. We estimate the Treasury yield curve will invert some time in mid-year 2019. Based on this assessment, we believe the likelihood of a US recession is still low for 2018 and 2019. 

 

 

So while the current stock market sell-off appears painfully sharp, we believe the bull market still has room to run. The stock market could correct 10% or more before it bottoms but we believe the market will rebound and retest the previous month's record high before the next recession. Risks to our assessment include the likelihood the Federal Reserve raises interest rates faster or higher than expected, the Federal government's weak fiscal position due to the "Trump Tax Cuts", and trade war politics negatively affecting economic data in a significant way. 

 

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