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Financial Markets Commentary For the week of October 22, 2018

Key Market Data

10/12/2018 10/19/2018 One Week Change YTD One Year
S&P 500 Index 2,767.13 2,767.78 +0.02% +5.11% +10.12%
MSCI EAFE Index 1,850.75 1,849.37 -0.07% -7.16% -4.77%
Barclays Capital U.S. Aggregate Bond Index 2,003.39 1,995.99 -0.37% -2.46% -2.21%
10-year Treasury Note Rate 3.162% 3.193% +3.1 basis points +78.7 basis points +87.4 basis points

It was another wild week for the stock market as worries about trade, foreign relations and contagion, the Federal Reserve’s plans, interest rates, and earnings news both good and bad sent the major indexes sharply up and down.

By the end of the week, the Dow had added only 0.4 percent, despite having gained 547.87 points on Tuesday, while the S&P 500 ended the week almost exactly where it began. The Nasdaq was the laggard of the group, falling 0.6 percent.

The Fed’s next steps

Rising interest rates have been a key contributor to the recent market volatility, and the release of the minutes of the Fed’s September meeting, at which it raised its rate, did little to allay those concerns. Based on those minutes, investors expect the Fed to raise its rate one more time this year and three times in 2019, though Fed committee members are apparently unsure of what the neutral rate will be – the interest rate that will neither be too tight and hamper growth nor too easy and lead to an overheated economy. Earlier last week, President Trump continued his recent criticism of the Fed’s higher rates, telling Fox News that the Fed was “my biggest threat.” Janet Yellen, the former Chair of the Fed, weighed in on that criticism, saying, “There’s no law against that. But I don’t think it’s wise,” especially if it led to investors doubting the Fed’s ability to manage inflation.

China, Saudi Arabia and Russia

While it’s hard to gauge the impact of the trade war on China, its gross domestic product (GDP) growth fell to 6.5 percent in the third quarter, the slowest pace since 2009. China’s top economic regulators went on the offensive to say all was well, and the Shanghai Composite Index finished up on Friday after an early slump, but that index is still down 22 percent this year. There was other news from abroad last week that added to the volatile mix, including the alleged murder of a reporter in Riyadh and whether members of the Saudi ruling family were involved, and the news that a Russian national was charged by the Justice Department with trying to interfere in the upcoming midterm elections.

Q3 earnings

The Dow got a boost on Friday when Proctor & Gamble announced its best quarterly earnings in five years, joining other companies whose positive earnings news moved the market last week such as Goldman Sachs, Netflix, Morgan Stanley, UnitedHealth Group, CSX and American Express; IBM and Textron were among the companies that fell short of expectations. FactSet estimates that third quarter earnings will be up 19.1 percent, which would be down from the second quarter’s 25 percent but still the third best reading since the first three months of 2011.

The Brexit, contagious Italy

Despite intense negotiations, there’s been little progress toward determining what the relationship will be between the European Union (EU) and Great Britain when the latter leaves the EU in March. Britain’s Prime Minister Theresa May prodded negotiators to “find a creative way,” while the EU’s lead negotiator Michel Barnier said a deal will require “much more time.” There’s apparently a provisional agreement to extend the current relationship until the end of 2020 if no deal is reached, though the final details of that plan seem to be up in the air. There are also rising concerns of contagion, reportedly discussed in a meeting by Mario Draghi, the President of the European Central Bank, who’s worried that Italy’s new populist government will flout the EU’s monetary guidelines; the yield on Italy’s ten-year bond hit a four-year high on Friday.

The rising federal deficit

Last week the government announced that the federal deficit rose 17 percent from a year earlier for the fiscal year that just ended to $779 billion, the largest shortfall since 2012. In addition, as a percentage of GDP, the deficit rose to 3.9 percent from 3.5 percent. Government spending was up 3.2 percent to $4.1 trillion, but revenue only increased 0.4 percent to $3.3 trillion. Both the White House and the Congressional Budget Office expect the deficit to hit $1 trillion this fiscal year.

Jobs outnumber job seekers

The U.S. Department of Labor reported that the number of available jobs at the end of August, 7.136 million, outnumbered the number of people looking for work by a record 902,000. Prior to March of this year, the number of job openings had never exceeded the number of job seekers in the survey’s seventeen years. The total number of jobs was up 18 percent from a year ago.

The housing market’s slowdown

Higher prices, lower inventories and rising mortgage rates are all taking a toll on the housing market, and last week the National Association of Realtors said that existing home sales fell 3.4 percent in September from August to 5.15 million. Sales were down 4.1 percent from September of 2017, the seventh straight year-over-year drop. Furthermore, housing starts were off 5.3 percent in September from August to an annualized rate of 1.12 million; starts were up 3.7 percent from a year earlier. And applications for building permits fell 0.6 percent in September from August to 1.24 million, down 1.0 percent from a year earlier. However, the National Association of Home Builder’s index of builder confidence rose to 68 in October from September’s 67; any reading above 50 indicates optimism. In other news, retail sales, perhaps affected by Hurricane Florence, were up 0.1 percent in September from August and 4.7 percent higher than a year earlier. Core sales, excluding automobiles, gas, building materials and food services, increased 0.5 percent. Business inventories were up 0.5 percent in August from July’s upwardly revised gain of 0.7 percent. Industrial production advanced 0.3 percent in September from August, while for the third quarter production climbed at an annual rate of 3.3 percent and 5.14 percent year over year. Manufacturing output rose 0.2 percent from the month before. Capacity utilization was unchanged at 78.1 percent. And first-time jobless claims for the week ending Oct. 13 fell 5,000 to 210,000; the four-week moving average added 2,000 to 211,750.

A look ahead

This week’s updates will include the latest on new and pending home sales, the Fed’s Beige Book report, wholesale and retail inventories, orders for durable and capital goods and the University of Michigan’s Consumer Sentiment Index. The government will also release its advance estimate for third quarter GDP, expected to come in at 3.4 percent.