We Wish We Were Wrong

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In our quarterly outlook we published last month, we discussed several factors that could lead to continued volatility over the next few months, including earnings, interest rates, trade, and the fact that volatility can be persistent. Indeed, volatility has continued to spike, and we still believe that the turbulence will likely continue for a few months. We should be clear – volatility is double sided, and we can have large upward swings along with large downward movements. For example, over the past six weeks, we’ve seen six days for which the S&P 500 has fallen by at least 1%, but there have been eight days for which it’s risen by at least 1%. Such volatility can cause concern, but periods of high volatility are a feature of a well-functioning stock market.

With respect to most of the factors we discussed last month, there is not much recent news. It’s likely the Federal Reserve Board will increase interest rates next month and will probably increase rates a couple of times in 2019 as long as the economy continues to grow. U.S. trade policy continues to be in flux – as a reminder, in general, the stock market reacts negatively to actions that will restrain free trade.

Earnings

There is news on earnings. Over the past month, most companies have released their third quarter earnings. 77% of those earnings announcements were higher than what analysts had previously forecasted (note that analysts tend to be pessimistic – on average, over the past five years, 69% of analysts’ forecasts were below the actual earnings). That means annual earnings have increased by 22% over the past year. More importantly, earnings are forecasted to grow by 18% over the next year. The single most important factor in valuation is corporate earnings.*

The Global Growth Cloud?

A concern more frequently cited by the press over the past few weeks is global growth. Factors cited in these articles (Google “global growth concerns” and steady yourself for a stream of depressing analysis) include slowing growth in China, low European and Japanese growth, and the chaotic impacts of Brexit. We must point out that if U.S markets have shown one consistent trait over the past few years, it’s the instinct to overreact to global economic news.

It’s instructive to review three such overreactions in this decade – for each of those, we will cite our response at the time, and show the returns to an investor if they invested in the S&P 500 over the next 12 months.**

Greece: In September of 2011, Greece seemed on the brink of defaulting on their debt, and U.S. stocks reacted negatively, falling by more than 6% on September 21 and 22. We opined that this was an extreme overreaction, but the market continued to show volatility over the next month. An investor buying U.S. stocks on September 22 would have earned 29% over the next year.

China, 2015: In August of 2015, concerns about Chinese growth (sound familiar?) caused the Chinese stock market to fall by 9% on August 24. In turn, the U.S. stock market fell by 6% in the first two minutes of trading and continued to show volatility over the next couple of months. On August 24, we urged caution for investors not to overreact. An investor buying U.S. stocks on the 24th would have earned 12% over the next year.

Brexit, 2016: On June 23, 2016, British citizens elected to withdraw from the European Union, and concern about the fallout from that decision (sound familiar again?) caused the S&P 500 to fall by 5% over the next two days. We again stated we believed this was an overreaction. An investor buying U.S. stocks on the 27th would have earned 22% over the next year.

It goes without saying (but our Compliance Officer requires us to say it anyway) that past performance is not indicative of future results. But it’s clear that looking at the past decade, it’s been a good idea not to panic because of global economic concerns.

What’s the Point?

Investors in U.S. stocks have experienced a lot of volatility and declines over the past few weeks. We expect such volatility to continue, but in general, the outlook for the U.S. economy and corporate profits is still solid. Our recommendations remain the same as they were last month – for investors with a long-term investment horizon, there is no need to take any action.

* Source of earnings analyst data is Standard and Poor’s

** All return calculations made by Savant Investment Group using daily data provided by Yahoo