Performance for Week Ending 10/05/18:
The Dow Jones Industrial Average (Dow) fell 0.04%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) lost 1.44%, the Standard & Poor’s 500 Index (S&P 500) closed down 0.97% and the Nasdaq Composite Index (NASDAQ) shed 3.21%. Sector breadth was negative with 7 of the 11 S&P sector groups finishing the week lower. The Consumer Discretionary sector (-4.37%) was the worst performer while the Energy sector (+1.86%) was the best.
||Closing Price 10/5/2018
||Percentage Change for Week Ending 10/5/2018
||Year-to-Date Percentage Change Through 10/5/2018
*See below for Index Definitions
MARKET OBSERVATIONS: 10/1/2018 – 10/5/2018
The major market indices kicked off the fourth quarter on a negative note as easing trade tensions, following the announced trade deal with Canada and Mexico, were offset by a spike in interest rates. The yield on the 10-year Treasury, which acts as a benchmark in setting rates for a whole range of business and consumer loans, including home mortgages, finished the week at the highest level in seven years.
While yields have been on the rise for most of this year, it was the speed at which they advanced over the past week that caught the market off-guard. Prompting the jump in rates was a bullish assessment of the U.S. economy by Fed Chairman Jerome Powell, the strongest reading for the ISM non-manufacturing index in 21 years, and the run up in oil prices. The move suggests investors are beginning to re-price inflation expectations in light of the economic strength and higher energy prices.
During the week, Cleveland Fed President Loretta Mester, played down the spike in yields, telling a conference in St. Louis that "the fact that interest rates moved on one day is not a concerning thing. Markets are volatile...it is still appropriate for us to be moving interest rates up gradually." Trade and geopolitical worries are also weighed on sentiment during the week after Vice President Mike Pence delivered a highly critical speech of Beijing, expressing dissatisfaction not only with the country’s economic policies but also its military and political behavior.
While the rise in yields appears to be due to the “right” reasons (i.e. strong economic growth), at some point higher rates will likely limit the markets valuation from expanding, putting the burden on underlying earnings growth to drive equity returns. Third quarter earnings season is set to kickoff over the coming weeks and according to Bloomberg, aggregate earnings growth for the S&P 500 is expected to expand by just shy of 20% for the quarter. Full year 2018 earnings are currently estimated to grow by 24.7% followed by 11.8% in 2019.
Payroll Report: On Friday, the Labor Department reported that nonfarm payrolls fell short of economists’ expectations with September nonfarm payrolls advancing by a disappointing 134K versus consensus expectations for a 185K gain. The September figure was the smallest gain in a year and a possible sign employers are starting to struggle to fill jobs. On a positive note, the prior two months’ worth of data was revised upward, adding an additional 87K to payrolls. The unemployment rate dipped to 3.7% (from 3.9%) and now stands at the lowest level in 48 years. Wages were in line with expectations with Average Hourly Earnings expanding by 0.3% during the month and by 2.8% on a year over year basis. According to the Labor Department, weather (Hurricane Florence) was a major issue during the month as 299K workers were unable to work due to poor weather conditions.
While the headline number was short of expectations due mainly to weather-related distortions, the overall report was solid and should keep the Fed on track for additional rate hikes in the coming quarters.
Focus on the Fundamentals: The S&P 500 has now delivered two consecutive quarters of 20%-plus earnings growth, the economy grew by 4.2% during the second quarter and according to the Atlanta Fed’s GDP Now model, Q3 GDP is tracking at a 4.1% pace. The markets valuation has contacted since the start of the year, leaving the S&P at a less demanding P/E multiple of 16-times the 2019 consensus earnings forecast. The headline noise surrounding tariffs and political dysfunction in Washington is not likely to go away anytime soon, however as long as the economy and earnings continue to grow, the market is likely to follow suit.
The Week Ahead: Third-quarter earnings season will begin in earnest with seven members of the S&P 500 index scheduled to report. Included in this group are Dow Jones industrial components Walgreens Boots Alliance Inc. and JPMorgan Chase & Co. On the data front, inflation will be a focal point with both the September producer price index (PPI) and September consumer price index (CPI) due out. September import and export prices and the University of Michigan’s preliminary October consumer sentiment survey will be released on Friday. The Fed speaking calendar will be very active with at least ten speaking events scheduled throughout the week.
The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally defined as the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.
Wilshire 5000 Total Market IndexSM represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The index is comprised of virtually every stock that: the firm's headquarters are based in the U.S.; the stock is actively traded on a U.S. exchange; the stock has widely available pricing information (this disqualifies bulletin board, or over-the-counter stocks). The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index.
Standard and Poor's 500© Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.
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