Behind the Market Pullback

We know volatility and large price swings can cause uneasiness and concern, so we wanted to share Legacy's perspective on the recent equity market weakness.

The volatility that is often associated with the month of October has arrived with stocks suffering from their worst one-day drop since February on Wednesday. A combination of higher bond yields, U.S./China trade tensions, uncertainty over the upcoming midterm elections, and worries about peak margins this earnings season have all contributed to the latest market sell-off with the S&P 500 Index down approximately 7% from its 2018 high.

  • The S&P 500 Index had one of its least volatile third quarters in history. The S&P 500 has gone 74 days without a 1% move - the 10th longest streak in history. The bottom line here is: equity markets were wound tight and some type of volatility was to be expected.

  • Pullbacks are normal. Even though stocks tend to average a 7-8% gain annually, they also tend to have three to four pullbacks each year (5-10% drops) and at least one 10-20% correction.

  • Stocks tend to do very well after midterm elections. The average 12-month gain off midterm election year lows is over 30%, and since 1946 the S&P 500 has never been down 12 months following midterm elections. That means we may have just entered the best nine-month period for stocks in the entire four-year presidential cycle.

  • Corporate profits remain quite strong. Consensus expects a 21% increase in S&P 500 earnings per share in Q3, supported by strong U.S. economic growth and tax cuts. The tariff impact has been minimal to date and repatriation has given companies a huge cash hoard that they may invest in growth or return to shareholders.

  • Over time, stocks tend to do well as interest rates rise, as long as rates are rising because of better economic growth. We believe that is the case now. When rates spike, as they have done in recent days, volatility usually spikes as well. However, we think much of the increase in interest rates is now behind us, which should enable stocks to settle down in fairly short order.

During the ups and downs of investing, our message remains the same: Focus on the fundamentals. And right now, fundamentals are strong. The U.S. economy is in excellent shape. Consumer spending - which accounts for 70% of economic growth - is growing solidly, consumer and business confidence is high, the strength in the job market is impressive, manufacturing surveys are near record levels, and by historical standards, interest rates are still fairly low.

While these type of pullbacks can be painful when we're in the middle of them, we maintain our optimism for the full year. We do not see the makings of a significant market downturn. In fact, we view this decline as a normal, healthy, and overdue pullback for the markets.

Markets always have and always will climb a wall of worry, rewarding those who stay the course and punishing those who succumb to fear. Warren Buffet expressed this beautifully when he said, "In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shock; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497." Such it has ever been, thus will it ever be.

Jonathan Darabos