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As Unresolved Issues Remain, U.S. Market Volatility are Unlikely to Dissipate

U.S. stocks have been on a wild ride lately, with major indexes hitting correction (-10%) territory in October before bouncing sharply, albeit still below September’s highs. The internal health of the rally off the recent lows has not been impressive. While stocks were “oversold” at the late-October lows—and investor sentiment had moved from excessive optimism to pessimism—there wasn’t quite the type of panic selling and investor despair that often serves as a sign of a firm bottom. Fundamentally, the major issues which contributed to the correction—the trade dispute with China, geopolitical uncertainty, tightening financial conditions, and concern over the future of Fed policy—remain in play. We expect ongoing bouts of volatility and a wider trading range heading into 2019. The potentially-good news is that seasonality is now in the bulls’ favor. In the one year following all midterm elections in the post-WWII era, the S&P 500 was up every time (Stategas Research Partners)—albeit not without plenty of drama at times, like the Crash of ’87, which came within a year of the 1986 midterms. We continue to recommend that investors use volatility to rebalance back toward longer-term strategic allocations in order to keep excess risk at a minimum.

Another reason for optimism that the secular bull market is not dead is that stocks did not experience a blow off top before the latest correction, which is often how bull markets end. Interestingly, according to BCA Research, if bull markets were historically divided into time deciles, the first and last deciles were by far the best performers. This is yet another argument against trying to time the market with all-or-nothing moves. If you missed the first tenth or the last tenth of a bull market, historically your returns would have suffered. Past performance is no guarantee of future performance of course, but it can help to inform our decision making.

Main Street vs. Wall Street

We’ve often noted that stocks are the ultimate leading indicator, meaning that Wall Street often starts to sniff out trouble before Main Street does. While we don’t think a recession is imminent, there are signals that peak economic and earnings growth rates have been reached and for stocks better or worse matters more than good or bad. Consumer confidence hit an 18-year high recently, a potential good signal for holiday spending, but perhaps not a particularly great sign for the future of economic growth as peaks have historically occurred fairly close to recessions.

And while remaining quite strong, we saw the Institute of Supply Management’s Manufacturing Index fall; while its leading new orders are well off their recent highs—likely at least partly a reflection of trade/tariffs uncertainty.

Meanwhile in Washington

The Federal Reserve made no move at its most recent meeting, as expected, but also did little to change expectations of another hike in December. The Fed has shown little desire to dissuade investors from the hawkish takeaway from Fed Chairman Powell’s early October comments. If that persists, concern that the Fed may make a “monetary mistake” may continue to weigh on markets. A pause in the tightening campaign might be cheered by markets, but only if economic growth remains healthy and inflation risk has ebbed. If the Fed is forced to lift its foot off the brake due to a sharper rolling over of growth—or in the face of rising inflation—markets would not likely take that as kindly.

Rancor between the two parties will persist, it’s unlikely much progress on the most significant issues will be made, and House-led investigations and/or subpoenas are likely to ramp up. For now though, enjoy the respite from campaigns, because the 2020 Presidential election season will be upon us in no time.

So what?

Positive seasonal factors associated with putting the midterm election in the rear view mirror could result in further rallies off the recent lows. The market’s whipsaws over the past month illustrate the importance of not trying to time the market. But given the uncertainties that still exist and the potential slowdown in both earnings and economic growth, we continue to recommend a fairly cautious approach to investing, including discipline around diversification and rebalancing.

 

Important Disclosure

Investment involves risk. Past performance is no indication of future results, and values fluctuate. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market, economic or political conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Diversification and rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.

Past performance is no guarantee of future results. Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.

The Consumer Confidence Index is a survey by the Conference Board that measures how optimistic or pessimistic consumers are with respect to the economy in the near future.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

About the author:
Liz Ann Sonder, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
Jeffrey Kleintop, Senior Vice President and Chief Global Investment Strategist
Brad Sorensen, CFA, Director of Market and Sector Analysis, Schwab Center for Financial Research

Content provided by Charles Schwab, Hong Kong
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