U.S. equities declined again last week, with the S&P 500 Index losing 0.7%,1 although the damage was mitigated by a rally on Friday that followed a stronger-than-expected employment report. The pending completion of the Federal Reserve’s quantitative easing program was one catalyst for the sell-off, as were broader concerns about global economic growth and the continued strength of the U.S. dollar. Oil prices declined sharply, driven by the rising dollar, growth concerns and increasing supply.1
Market Correction Fears Are Rising
Equity prices have been falling for the past couple of weeks and from peak to trough are now down around 5%.1 This exceeds the 4% sell-offs we saw in August and April, but is less than the 7% downturn we witnessed in January.1 Since economic and market fundamentals haven’t shifted notably in recent weeks, it appears that this pullback is being driven by a heightened focus on previously existing risks, chiefly worries about global growth, geopolitical tensions and a pending shift in monetary policy. Although these worries are not new, they are coinciding with a general sense among investors that markets are overdue for a correction.
Friday’s jump in stock prices could mark the end of the current slide, or may simply be a blip in the midst of a more pronounced pullback. Either way, we believe relatively higher levels of volatility will persist as markets continue to look sloppy.
Weekly Top Themes
1. Strong jobs growth points to an accelerating economy. Friday’s employment report showed that 248,000 new jobs were created in September, surpassing expectations.2 Additionally, numbers for the preceding two months were revised upward, and the headline unemployment rate fell to 5.9%.2
2. The U.S. economy is diverging from other markets. Last week’s announcement by Ford Motor Company that issues in Russia, the eurozone and Brazil were hurting sales served as an important reminder that U.S. growth is stronger than in many other areas of the world.
3. Several market trends have gained traction and could persist: weak performance by U.S. small cap stocks, commodity prices coming under pressure and the U.S. dollar strengthening. The combination of a strengthening dollar and a pullback in commodity prices is also putting pressure on emerging market equities.
4. Commodity price weakness can largely be attributed to slower global economic growth. The slowdown in China in particular has hurt industrial commodity prices. Chinese authorities are continuing to engineer a growth slowdown, which is one reason we believe commodity prices should continue to drift lower.
5. We think the odds of a Republican takeover of the U.S. Senate are climbing. If the GOP takes control of the Senate, we think it would be a positive for the energy industry, medical device companies and defense stocks but a negative for hospitals and HMOs.
The U.S. Economy Continues to Outpace Other Regions
U.S. economic growth has been uneven, but continues to accelerate. We have seen a number of potential stumbling blocks over the past few years, but this economy has proven to be highly resilient, and we do not believe its current trajectory will be derailed. Outside of the United States, in contrast, economic risks appear to be rising. Europe is a notable global weak spot and the engineered slowdown in China remains a concern.
Divergence between the United States and other markets remains a growing theme. Slower global growth is benefitting the U.S. economy in some ways, such as via lower commodity prices. But at some point this divergence could put pressure on U.S. multinational corporate earnings and act as a headwind for U.S. growth through such factors as declining exports.
In any case, we believe the current backdrop should be supportive for most risk assets (with commodities being a notable exception). Volatility is rising, and periodic market setbacks are inevitable, but the long-term case for equities remains sound.
1 Source: Morningstar Direct, as of 10/3/14 2 Source: Bureau of Labor Statistics
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. Euro STOXX 50 Index is Europe’s leading Blue-chip index for the Eurozone and covers 50 stocks from 12 Eurozone countries. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. FTSE MIB Index is an index of the 40 most liquid and capitalized stocks listed on the Borsa Italiana. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The MSCI World Index ex-U.S. is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets minus the United States. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
RISKS AND OTHER IMPORTANT CONSIDERATIONS
The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Noninvestment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.
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