News & Our Thinking

(The St. Louis Post-Dispatch)

Nov. 6, 2018 (David Nicklaus)

A turbulent October changed a lot about the stock market.

As the month began, investors were sitting on solid gains for the year and maybe contemplating how they might spend the new wealth. By Halloween, they were spooked enough to consider heading for the hills.

The market didn’t suffer an official correction during the month, but it came close. On Oct. 29, the Standard & Poor’s 500 index closed 9.8 percent below the record it set in late September, rallying late in the day to avoid a 10 percent loss that would have been deemed a correction.

All of 2018’s gains had evaporated at that point, although with a few strong days in early November the S&P 500 is now up 2.4 percent for the year.

Ken Crawford, senior portfolio manager at Argent Capital Management, said he fielded calls from nervous clients wondering if they should sell and wait for calmer waters. He responded that, to him, the market looks healthier now than it did in September.

The economic backdrop hasn’t changed. We’re still seeing strong job gains without much inflation.

While the plummeting stock indexes were making investors nervous, the companies behind the indexes were doing quite well. Three-quarters of the S&P 500 companies had reported their third-quarter profits by Friday and, according to FactSet, those profits were up 24.9 percent from a year ago.

Moreover, not all of that good news was expected. Companies are beating earnings estimates by 6.8 percent, on average, well above the five-year average of 4.6 percent.

Looking ahead, analysts expect 9.4 percent profit growth next year, and the third-quarter reports didn’t change that forecast much. So, stocks have gotten cheaper even as the companies they represent are earning more money.

“It seemed like an overreaction to me,” Crawford says of the October selloff. “We are more enthusiastic coming out of October than we were going in.”

During the month’s worst days, investment commentary focused on macroeconomic worries, such as whether the Federal Reserve might raise interest rates too fast or whether a trade war might hurt the economy.

The Fed has been careful to telegraph its series of small, gradual rate increases, but William O’Grady, chief market strategist at Confluence Investment Management, said some Fed officials’ speeches last month created doubts.

“I think it was mostly the Fed,” he said of the market downdraft. “It’s not that people actively fear the Fed, but they are starting to become uncomfortable because they don’t know what the Fed is going to do.”

Norman Conley, chief investment officer at JAG Capital Management, sees healthy signs that the “risk off” sentiment didn’t spread beyond the stock market. Credit spreads, a measure of the bond market’s willingness to lend to risky companies, remain narrow, for instance.

If credit remains plentiful, the economy isn’t likely to fall into recession. And if the economy keeps growing, companies should deliver at least another year or two of strong earnings growth.

“Corporate America is in great shape,” Conley says. “If you’re willing to look at the cup as half full, there is a lot to look at.”

October even helped resolve the market’s narrowness problem. As high-fliers like Amazon and Netflix fell at least part way back to Earth, investors turned their attention toward long-neglected sectors like industrials and financials.

Sudden drops in the market are never fun, but we need months like that to set the stage for gains later on.