Our Opinion: 2018

An end to the bull market?

There was a sea of red yesterday on Wall Street, with all major US equity market indexes closing down over 3%. Is the bull market resetting or ending?

The S&P 500 fell 3.3%, the Dow 3.15%, and the NASDAQ 4.1%. Over the past week, the S&P 500 has experienced a 4.8% pullback and the UK FTSE100 builds on those falls today.

While significant, it’s important to keep these moves in perspective: the S&P 500 rose nearly 8% in the third quarter of the year, and the year-to-date total return for the index is 5.8%.

There are a few factors contributing to this sell-off.

First, the recent rise in rates has made stocks relatively less attractive. The 10-year Treasury yield has risen over 4% in the past six weeks, including almost 2% in October alone, as the market has priced in a more aggressive outlook for US interest rate hikes. As a reminder, the 10-year yield also rose 4% in January—a catalyst for the early February market correction—before stabilizing for six months. Importantly, the 10-year yield fell as the market sold off today, and thus still functioned as a portfolio stabilizer.

Second, US stocks may be belatedly pricing in the potential cost of tariffs on earnings. In the past few days a handful of companies exposed to trade with China have discussed how the tariffs are starting to adversely impact their business through both higher costs and slower demand. US equity markets have been resilient to rising trade tensions compared to their global counterparts, leaving them susceptible to pullbacks as the costs become more apparent.

Third, rising rates have fuelled concerns that the economy has entered the latter stages of the business cycle and thus growth will slow. In the past week, defensive sectors have outperformed the market. Growth stocks are also down 6.7%, a result of the strong valuation expansion of momentum stocks unwinding. Meanwhile, value stocks are down only 3%, which shouldn’t outperform if there was significant risk of economic growth rolling over.

What hasn’t changed over the past week are the solid US economic and earnings fundamentals. With Q3 earnings season about to start, EPS (earnings per share) is likely to grow by around 23-24%, very similar to the first two quarters of this year. Granted, the focus will be on company guidance for future earnings, but for most sectors the tariffs announced thus far are not that impactful and underlying trends in even affected sectors (materials, industrials, tech, and consumer discretionary) still look fairly healthy. In addition, the strong growth momentum should enable the economy to readily absorb the higher rates, even if they continue to rise at a moderate pace.

Given the fundamental outlook, an overweight position in risk assets is still the tactical asset allocation offered by our strategic partners at UBS. This includes an ‘overweight’ in global equities and emerging market hard currency sovereign bonds. Periods of rising volatility and market pullbacks are likely to be more common as the cycle matures. Thus, the past week’s market action is fairly ‘normal’ for this stage of a bull market that’s likely to extend for a while longer.

11th October 2018