October has gotten off to a difficult start. Concerns about the trajectory of interest rates coupled with reduced global growth expectations and trade uncertainty (particularly between the U.S. and China) have been factors in the downward moves. While a spike in volatility can be unnerving, we share in our letter below that they are a normal part of the market cycle and often a healthy pause that may become clearer with hindsight.
A quick look at interest rates. The 10-year Treasury yield rose to over 3.2% recently due to strength in the economy and a more hawkish tone from the Federal Reserve. Fed Chairman Jerome Powell has made clear his intention of moving towards a policy of normalization of interest rates and that Fed policy was still a “long way from neutral.” Higher rates are a way to cool the economy, something that could portend lower earnings multiples on the stock market i.e. lower prices. The good news is that rate increases are being instituted into a healthy, growing economy- a positive environment.
On the trade front, we have seen some firms mention that they are seeing an impact from tariffs and the market is seemingly extrapolating what might happen if the dispute drags on. Earnings have been very solid this year and supportive of the bull run. Anything that seems to threaten earnings can be cause for pause. As discussed in our last letter, we view the renegotiation of trade as fluid and with unpredictable results. The combination of rate hikes, trade uncertainty, and potential slowing in earnings seem to have been enough to tilt the markets down near-term. Nobody truly knows the reason but what is true is that we’ve had more sellers than buyers so far this quarter.
The technology sector, with its above average exposure to rates and trade and owners of a preponderance of the returns the last few years, have taken the brunt of the recent downdraft. Most technology stocks are truly long-duration assets, and potentially more sensitive to fluctuations in the outlook for interest rates. Many also do substantial business in China. For the past few years, these risks have largely been overwhelmed by strong earnings growth, but there will now be enormous scrutiny on third quarter profit reports in the weeks ahead. We continue to believe that technology and disruptive firms will play an outsized role in market returns over the long-term but are certainly susceptible to bouts of profit taking and price-resetting.
Our letter below provides a recap on last quarter and offers historical context for the mid-term elections. It also provides additional insight on market volatility. On the plus side, we are buoyed by the strength of the economy, moderate inflation, and a market that is not overheated with equity enthusiasm. On the flip side, we are mindful of the potential for economic slowdown as liquidity is pulled from the system. As always, please do not hesitate to reach out to discuss your personal concerns and circumstances.
Click below to download the PDF for Third Quarter 2018: