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Some Thoughts on the Recent Equity Market Pullback
By Washington Trust / October 12, 2018

The S&P 500 Index has dropped nearly 7% from its all-time closing high on September 20th1. While it is never possible to explain market behavior with certainty, rising interest rates and bond yields coupled with the unresolved trade dispute with China are offered as two plausible triggers for the decline. The Federal Reserve has been steadily raising the Federal Funds rate by 0.25% on a quarterly basis1 and did so yet again (to no one’s surprise) at the September month-end FOMC meeting1. Subsequent commentary from Fed officials including Chair Jerome Powell was more hawkish which may have alarmed investors. However, a modest change in “Fedspeak” verbiage and a marginal boost to the outlook hardly seems to herald a significant policy shift.

The trade issue, of course, has festered since the beginning of the year and provided the backdrop for a rocky first quarter for equity markets. On the positive side, an agreement was reached with Mexico and Canada with NAFTA rebranded as the USMCA. On the other hand, there has been little progress with China amid increasing acrimony and the potential imposition of harsher tariffs on January 1, 2019. Yet, the hostile posturing on both sides may just be a negotiating tactic and a scheduled November summit between President Trump and China’s President Xi will hopefully prove productive2.

Concerning interest rates, despite eight rate hikes during this tightening cycle to date, the Fed Funds rate sits in a range of just 2.0% - 2.25% while the yield on the 10-year Treasury note has settled back to 3.15% after touching 3.25% last week1. In our view, bond yields have risen for the right reason: the economy is strong with the unemployment rate along with jobless claims plummeting to a 50-year low3. The question for investors is whether the rise in interest rates will throttle back economic growth.

What we can say for now, is not yet, at least, and GDP growth slightly in excess of 3% seems potentially achievable in the back half of 2018 which suggests the economy could enter 2019 with considerable momentum4. Further, interest rates are not the sole determinant of financial conditions. While credit spreads have widened in the past week, they are approximately at the same level as at the beginning of the year, indicating credit is widely available. Lastly, recent inflation data has been reassuring and the Fed does not appear behind the curve with a need to accelerate rate hikes.

We do not see any resulting economic weakness from this market downturn and, in all likelihood, U.S. stocks should be able to pull out of this “mini-panic”. On a micro level, there may be valid concerns over interest rate sensitive industries such as housing and autos, or China trade plays including semiconductors and (again) autos. In the wake of the selloff, with the earnings outlook robust, stock market valuation appears reasonable with the S&P 500 Index trading at 15.6 times the Washington Trust Wealth Management’s 2019 estimated earnings4.

 

 

Disclosure: Sources: (1) Bloomberg, (2) The New York Times; (3) U.S. Bureau of Labor Statistics; (4) Washington Trust Wealth Management. The views expressed here are those of Washington Trust Wealth Management and are subject to change based on market and other conditions. Investment recommendations and opinions expressed in these reports may change without prior notice. All material has been obtained from sources believed to be reliable but its accuracy is not guaranteed. Investing entails risk, including the possible loss of principal. Stock markets and investments in individual stocks are volatile and can decline significantly in response to issuer, market, economic, political, regulatory, geopolitical, and other conditions. Investments in foreign markets through issuers or currencies can involve greater risk and volatility than U.S. investments because of adverse market, economic, political, regulatory, geopolitical, or other conditions. Emerging markets can have less market structure, depth, and regulatory oversight and greater political, social, and economic instability than developed markets. Fixed Income investments, including floating rate bonds, involve risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. Interest rate risk is the risk that interest rates will rise, causing bond prices to fall. Past performance does not guarantee future results. The S&P 500 Index is an unmanaged index and is widely regarded as the standard for measuring large-cap U.S. stock-market performance. In addition, the S&P 500 Index cannot be invested in directly and does not reflect any fees, expenses or sales charges. Further, such index includes 400 industrial firms, 40 financial stocks, 40 utilities and 20 transportation stocks. The information we provide does not constitute investment or tax advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell any security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. Please consult with a financial counselor, attorney or tax professional regarding your specific investment, legal or tax situation.



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The opinions expressed in this blog are those of the author and may not reflect those of Washington Trust Wealth Management. The information in this report has been obtained from sources believed to be reliable, but its accuracy and completeness are not guaranteed. Any opinions expressed herein are subject to change at any time without notice. Any person relying upon this information shall be solely responsible for the consequences of such reliance. Performance is historical and does not guarantee future results.

Such information does not constitute legal or professional advice as all situations are unique and are based on individual facts and circumstances.

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