At the start of this year, I was urging investors to remember that we were getting into the mature part of the business cycle, with all the uncertainty that implies. Strong earnings growth could fuel equity markets through early 2018, but that could provide an opportunity to trim highly valued stocks and rotate into something more defensive—that was my message.
Fittingly, it took the Halloween month of October to give us the scare that we worried about. In a selloff that included a 3% down day and some rollercoaster sessions, the S&P 500 flirted with a technical correction of 10% off of its peak.
Halloween lasts but one day, of course, and we are now into the end-of-year holiday season. That often coincides with a rally in equities, and optimists have the upper hand so far in November. Does that mean October gave us an opportunity to take on risk again at attractive valuations? I’m not sure it did, and we stand by the message articulated at the start of the year.
Bears Have Pounced
At first glance, the October selloff did seem divorced from economic fundamentals. The U.S. posted further strong GDP data last week, and while the current earnings season was always going to struggle to keep pace with recent quarters, more companies are beating analysts’ estimates, and by greater margins, than the long-term average.
On the other hand, less-bullish guidance for future quarters has been a consistent feature of this earnings season. In addition, investors hammered GE as it slashed its dividend, punished Google and Amazon for missing revenue expectations even as they beat earnings estimates, and took a bite out of Apple for announcing that it would no longer report unit sales. Small-cap and more cyclical names have suffered steep double-digit losses. Bears have pounced aggressively on marginal top- or bottom-line misses, or even modest beats or cautious outlooks—especially if the business in question is at all cyclical.
Those bears also smell trouble outside of the U.S.
Europe’s earnings season disappointed and the latest data from Purchasing Managers’ Indices (PMIs) were weak. In China, last week’s official PMIs revealed further slowing in manufacturing, services and export orders, sending the renminbi to its lowest levels in over a decade. The big Asian exporting economies of Taiwan, Malaysia and Thailand all saw their PMIs fall into contraction last week, too, just as news emerged that the U.S. was preparing tariffs on the remainder of its imports from China.
Alongside any hawkish noises from the Federal Reserve, these risks—prolonged slowdown in Europe and China and the impact of tariffs—are the ones we have been watching out for this year. In October, they spooked the market. Investors are looking over the horizon, beyond the strong absolute reported earnings in the U.S.—and the key question on all our minds is where we are in the cycle.
We believe the recent selloff in the market is more of a late-cycle correction than an indication that the cycle is over. However, I am not convinced October left us with the sort of “risk-on” opportunity that we got in early 2016, when a similar divergence opened up between nervous markets and apparently robust fundamentals. We are simply two years further into the cycle.
Could we see 5 – 10% upside in U.S. equities from where we are now? For sure. But unless Europe’s data troughs, China presses ahead with more aggressive stimulus, and we get clear confirmation that the cycle will extend much further and that the Fed is nearly done raising rates, it is difficult to see how we could get much more than that. The S&P 500 Index, at around 2,740, already trades at 16 times next year’s estimated earnings.
Fears were likely overdone in October, and we believe there is still equity upside. But the concerns about a turn in the cycle remain justified, and in our view that makes subsequent rallies another good chance to gradually rotate to something more defensive.
Halloween lasts but one day. But the brutal market in October will not soon be forgotten.
Joseph V. Amato is President of Neuberger Berman Group LLC and Chief Investment Officer—Equities at Neuberger Berman. He is also a member of the firm’s Board of Directors and its Audit Committee. To learn more, see Mr. Amato's bio or visit www.nb.com.
In Case You Missed It
- U.S. Personal Income and Outlays: Personal spending increased 0.4%, income increased 0.2% and the savings rate decreased to 6.2% in September
- U.S. Consumer Confidence: +2.6 to 137.9 in October
- S&P Case-Shiller Home Price Index: August home prices were flat month-over-month and increased 5.5% year-over-year (NSA); +0.1% month-over-month (SA)
- Bank of Japan Central Bank Meeting: The BoJ made no changes to its policy stance
- Euro Zone Q3 2018 GDP (first estimate): +1.7% annualized rate
- Euro Zone Consumer Price Index: +0.5% in October month-over-month and +1.1% year-over-year
- ISM Manufacturing Index: -2.1 to 57.7 in October
- U.S. Employment Report: Nonfarm payrolls increased 250,000 and the unemployment rate stayed at 3.7% in October
What to Watch For
- Monday, 11/5:
- ISM Non-Manufacturing Index
- Wednesday, 11/7:
- Euro Zone Purchasing Managers' Index
- Thursday, 11/8:
- FOMC Meeting
- Chinese Imports/Exports
- Friday, 11/9:
- U.S. Producer Price Index
Statistics on the Current State of the Market – as of November 2, 2018
|S&P 500 Index||2.4%||0.4%||3.4%|
|Russell 1000 Index||2.6%||0.5%||3.2%|
|Russell 1000 Growth Index||2.2%||0.5%||7.1%|
|Russell 1000 Value Index||3.0%||0.6%||-0.8%|
|Russell 2000 Index||4.3%||2.4%||1.8%|
|MSCI World Index||2.8%||0.7%||-1.1%|
|MSCI EAFE Index||3.4%||1.2%||-7.7%|
|MSCI Emerging Markets Index||6.1%||4.3%||-11.8%|
|STOXX Europe 600||3.4%||1.1%||-9.0%|
|FTSE 100 Index||2.2%||-0.5%||-4.3%|
|CSI 300 Index||3.7%||4.3%||-16.6%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||-0.2%||-0.1%||0.3%|
|Citigroup 10-Year Treasury Index||-1.1%||-0.5%||-4.8%|
|Bloomberg Barclays Municipal Bond Index||-0.5%||-0.3%||-1.3%|
|Bloomberg Barclays US Aggregate Bond Index||-0.7%||-0.3%||-2.7%|
|Bloomberg Barclays Global Aggregate Index||-0.6%||0.0%||-3.4%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||-0.1%||0.1%||3.8%|
|ICE BofA Merrill Lynch U.S. High Yield Index||0.2%||0.2%||1.0%|
|ICE BofA Merrill Lynch Global High Yield Index||0.3%||0.3%||-1.0%|
|JP Morgan EMBI Global Diversified Index||-0.1%||0.4%||-4.8%|
|JP Morgan GBI-EM Global Diversified Index||0.7%||1.5%||-8.6%|
|U.S. Dollar per British Pounds||1.1%||1.5%||-4.2%|
|U.S. Dollar per Euro||0.1%||0.4%||-5.2%|
|U.S. Dollar per Japanese Yen||-1.5%||-0.2%||-0.4%|
|Real & Alternative Assets|
|Alerian MLP Index||-0.3%||0.2%||-2.4%|
|FTSE EPRA/NAREIT North America Index||0.1%||-0.8%||-0.8%|
|FTSE EPRA/NAREIT Global Index||1.0%||0.7%||-4.1%|
|Bloomberg Commodity Index||-1.3%||0.8%||-3.3%|
|Gold (NYM $/ozt) Continuous Future||-0.2%||1.5%||-5.8%|
|Crude Oil (NYM $/bbl) Continuous Future||-6.6%||-3.3%||4.5%|
Source: FactSet, Neuberger Berman.