Market Update October 23rd, 2018

Stocks today are re-testing their October 11th lows. This is a normal pattern following a sudden sharp pull-back like the 7% decline of October 9th through 11th. With the S&P 500 index at 2704 this morning, it is now down 7.4% from its recent peak of September 21st. We certainly may go lower, but we think the next up-leg should resume before long.
Foreign stocks have experienced a considerable correction this year as the tariff battles escalated instead of improved. U.S. stocks have also been in a fairly severe rolling correction all year long. Nearly every sector has taken its turn getting punished, with the only exception being the select group of everyone’s favorite growth stocks (Amazon, Google, Netflix, Microsoft, etc.), and a handful of other growth stocks that are riding hot streaks. The Dow’s performance has been bolstered by a few stocks also (Boeing, Visa, Apple, etc.). These last holdouts have been propping up the U.S. market returns all year (especially given their now out-sized allocations in the indexes) helping mask the severity of this rolling correction. (So far this year the entire S&P 500 return has come from just ten growth stocks.)
We believe this current market pullback is continuation of the year-long rolling stock correction that began in February, and we believe it is now likely in its last phase…a phase that may finally hit these last crowded and more expensive holdouts the most. If that happens, it will make the indexes fall more than the average diversified portfolio that has already been through most of the correction.
We believe when the next market up-leg begins, it should also finally be more favorable to U.S. value stocks and international stocks for the first time in a long time. If nothing else, just because of the extreme value disparity. We think the global crowding into U.S. stocks is also likely close to peaking, and foreign markets may start to outperform again in the next couple of years. Yes the U.S. has made itself more attractive with the tax cuts, more business friendly policies, and new tariffs. But not at any price. Eventually price/value matters, and investors begin to see better values elsewhere again…in addition to U.S. stocks. Especially as the rest of the world reacts to follow the U.S.’s policy lead.
Overall we continue to favor both U.S. and International stocks over bonds and cash. We still don’t yet see warning signs of a recession on the horizon in 2019 or 2020, and still think stocks remain attractive. But it may be time to trim some profits from those favorite growth stocks, and shift money toward undervalued U.S. value stocks and foreign markets.
Foreign stocks have Price/Earnings ratios that now exceed international developed market stocks by 3.3 and emerging market stocks by 6.6. When variances this wide have occurred in the past 20 years or so, 80% to 90% of the time the foreign markets outperformed the U.S. markets over the following year. And if we get any improvement to, or resolution of, the U.S./China tariff war, that should unleash a global market rally.
The lion’s share of 3rd quarter earnings reports will be released the rest of this week and next, so this may re-focus investor attention on continued strong economic and earnings growth. However, since we are in another fear phase, don’t be surprised if investors focus on any negatives they can find also.
Hang in there. There may be more correction to come before this secular bull market is over, but we think we should soon move into another up-leg.