The Seasons of Investing

Key Points

  • The stock market has clearly entered a more volatile phase; in keeping with late-cycle tendencies and evident risks about which we’ve been writing all year. It’s too soon to declare the bull market over, but we’d caution against adding risk to portfolios.

  • Earnings season has been decent on its face, but investor reaction has often been severe. For both earnings and the economy, we are likely past the peak in growth rates. Meanwhile, Fed uncertainty is adding to the consternation of investors.

  • Global stock markets have struggled as the season of “sugar highs” appears to be coming to an end.

“There is a time for everything, and a season for every activity under the heavens.”
- Ecclesiastes 3:1

Seasonality changes

The last several weeks have brought a distinct change in market behavior and character; with elevated volatility, triple digit moves in the Dow back in vogue, and the NASDAQ and Russell 2000 (small caps) entering correction territory.

Volatility has increased


This shouldn’t be much of a surprise as interest rates have moved higher, financial conditions have tightened, worries about peak growth have increased, trade concerns have grown, midterm election rhetoric has escalated, global growth has slowed, and Fed uncertainty has risen. Put this more uncertain “season” on top of the worst month of the year historically for equity returns and you have the recipe for more volatility. But a potential positive offset is that we’re entering what has historically been a strong seasonal period for the markets. Novembers and Decembers of midterm election years have historically been quite strong. And in all years, going back to 1952, the three-month period beginning in November has been the best three months of the year. Of course past performance is no guarantee of future results but it can be comforting to have some historical tailwinds.

Additionally, the recent uptick in volatility has allowed investor sentiment—a contrarian indicator—to drop out of the excessive optimism zone according to the New Davis Research (NDR) Crowd Sentiment Poll (which aggregates seven distinct sentiment measures). This could provide more near-term support for stocks and set the stage for further relief rallies. That said, we remain cautious about equities and continue to recommend investors take no risk beyond their longer-term strategic U.S. equity allocations, and use volatility to rebalance as necessary. We have also expressed this caution with our bias toward large caps over small caps; and our sector recommendations, which have become more defensive in nature, offering a ballast within equity portfolios (for more see Interested in Some Defense?) .

Peak season?

Earnings season has been decent as far as results go to this point but as we often say, “better or worse matters more than good or bad.” Earnings growth rates have been trending down this year, from 27% in the first quarter, to 25% in the second quarter, to an expected 24% in the third quarter and an expected 19% in the fourth quarter (according to ThomsonReuters). But growth then takes a meaningful dip in 2019; largely thanks to simple “math:” Once we move into 2019, earnings will be compared in year-over-year growth rate terms with the tax-cut juiced earnings of this year. Expectations are for 8-9% earnings growth for next year’s first half (ThomsonReuters). And although current earnings remain strong and the “beat rate” remains healthy at more than 80%, investors’ reaction to results has been fairly severe. According to Bespoke Investment Group, for the third quarter earnings season through October 24, the one-day decline for earnings misses averaged nearly -5%; but perhaps more telling is that even earnings beats saw an average decline (albeit a slight one). Additionally, tariff concerns are increasingly being mentioned in corporate conference calls according to data from FactSet, which could impact companies’ willingness to spend on capital expenditures as well as dent profitability. As an aside, the latest Federal Reserve’s Beige Book report on the economy had a rash of references to pessimistic corporate commentary associated with tariffs’ impact on business. And the major area of concern, the Unites States’ dispute with China, shows few signs of thawing, with both administrations appearing to dig in their heels.

The tariffs are not yet having a discernable impact on the U.S. economy, with industrial production continuing to move higher (see first chart below) and most regional surveys such as the Empire Manufacturing Index remaining elevated (the Richmond Fed survey was decidedly less rosy). In addition, if the remaining pending and potential tariffs kick in, the impact on U.S. gross domestic product (GDP) will become more significant (see second chart below).