US and global stock markets market declined on Wednesday. Major US indices dropped by more than 3% and International markets by a bit less, depending on the specific asset class. They are down again mid-day Thursday, as I complete this.
Whenever there are sudden or steep declines that appear out of the ordinary, investors and analysts try to analyze and determine the cause and effects.
In the context of longer term stock market activity, which generally has been positive for a number of years, this decrease should not be overly worrisome.
The drop may be attributed to a number of factors, which work in a circuitous cycle. Corporate earnings and the economy have been strong. Unemployment is down. It is hard to find good job candidates. Interest rates since 2008 have been historically low. Inflation has been moderate at around 2%.
The Federal Reserve has raised short term rates, which we feel is quite appropriate, in response to the strong economy. The increase in interest rates will benefit many of our clients, as the returns on your fixed income investments will be rising. However, higher short term rates potentially slow the economy. Higher interest rates make it more expensive to borrow to purchase a home, finance a new or used vehicle, or obtain business financing.
While the 10 year US Treasury note yield had risen to over 3.25% early Wednesday, it declined to around 3.15% on Thursday morning. This is the circuitous impact and how various financial markets adjust and self-correct. Concerns about rising interest rates caused growth expectations to be reduced, which then caused the decline in stock prices and in the 10 year interest rate, as well as a drop in the price of oil, due to reduced demand expectations. All in one day, or in a few hours.
We don’t feel anything has significantly changed this week, from the last few months, regarding the economy. Corporate earnings are the key driver for the stock market in the long term. If current earnings and future earnings expectations are good, in general, that drives stock prices higher.
Corporate earnings for the third calendar quarter of 2018 are beginning to be released this week. Thursday morning Delta and Walgreens, for example, announced solid earnings and good future guidance. More results will be released Friday and over the next few weeks. We think these earnings announcements will strongly influence the market’s near term direction.
There are certainly still concerns about trade issues with China. The US budget deficit continues to grow and that cost will be exacerbated by the increase in interest rates, as the US Treasury will continue to need to borrow more money. Tax reform has increased corporate earnings but the impact has yet to appear in US Treasury receipts.
Warren Buffet frequently cites his mentor, Benjamin Graham, for stating that “in the short run, the (stock) market is a voting machine but in the long run, it is a weighing machine.” We agree with this quote.
In the short term, the stock market can be volatile and unpredictable. However, investors who are focused on the long-term, who remain disciplined, patient and diversified, have been amply rewarded.
Nothing has changed our view and future long-term perspective.
As always, if you have questions about market activity or it’s impact on you, please contact our firm. That is what we are here for.