Financial Review

Have a Great Weekend

…Stocks continue to fall; multiple issues affecting markets. 3Q GDP decelerates to 3.5%. Tax cut sugar high passes.

Financial Review by Sinclair Noe for 10-26-2018


DOW – 296 = 24,688
SPX – 46 = 2658
NAS – 151 = 7167
RUT – 16 = 1483
10 Y – .06 = 3.08%
OIL + .29 = 67.62
GOLD + 1.20 = 1233.80


On Wednesday, the Dow Industrial Average’s high for the day was 25,306. Today the session low was 24, 445 – this represents an 850-point spread between Wednesday and today. Volatility has returned to the markets. With the S&P 500 only five weeks removed from its all-time high, we’ve not been definitive about labeling this move a new cyclical bear market. But it’s very likely we are experiencing one. Today’s decline sent the S&P 500 into a correction, as the index is now down about 10.5% from its September 21 year-to-date intraday high of 2,940. The Nasdaq entered a correction on October 11. The Dow is down about 9% from its record high of 26,951.  The Dow on Thursday climbed 400 points, trying to regain losses from previous consecutive dismal days; then the Dow dropped more than 500 points in today’s session. Both the Dow and the S&P 500 have wiped out gains this year, with the Nasdaq the only one of the major indexes holding on to a year-to-date gain of 3.3 percent. The Dow is down 5.9 percent in October, on pace for its worst month since August 2015. The Nasdaq fell 3.8 percent for the week, its biggest weekly drop since March 23, while the Dow was down 3 percent and the S&P 500 was down 4 percent on the week.


This comes even as companies have actually been reporting relatively strong earnings. It also comes as companies have expressed concerns about guidance – not that it is falling over a cliff – just that management isn’t sure what to expect, and we know the markets hate uncertainty. This month’s selloff by investors has erased about $5 trillion in value from global stock and bond markets in October alone. So, now we start talking about how much pain the markets will inflict on investors before something breaks. This does not mean that stocks a destined to fall; we could see a bounce, even a significant rally before stocks take another hit, but it seems inevitable that there will be another leg down – just because there are so many different issues that are pulling at the markets.


Crude oil futures posted their third consecutive weekly loss. U.S. West Texas Intermediate crude ended this week down 2.2 percent and has now tumbled about 12 percent from its recent high of $86.74 on Oct. 3. At the start of October, oil prices were rising on signs that U.S. sanctions are shrinking Iran’s crude exports faster than anticipated, potentially leaving the world with a shortage of oil. The sanctions are expected to cut crude exports from Iran, OPEC’s third biggest oil producer, by about 1 million barrels per day. But we have seen a burst of supply that came on the market. After the recent assassination of Washington Post journalist Jamal Khashoggi, it appears the Saudis are taking the necessary steps to cultivate their business relationships.


Gross domestic product decelerated a bit to a 3.5% annual pace in the third quarter, down from torrid 4.2% pace in the prior three months. GDP is the official measuring stick for the U.S. economy. The economy looks like it will expand above a 3% rate in 2018. That hasn’t happened since 2005. At the same time, inflation cooled in the third quarter. Consumer spending rose 4% in the third quarter, even stronger than the prior three months. This was offset by a slowdown in business and residential investment. Household investment has fallen for three straight quarters. The value of unsold goods, or inventories, added 2.1 percentage points to growth. A significantly larger trade deficit took 1.8 points off top-line growth. Final sales to private domestic purchasers, a good measure of domestic demand that excludes inventories and trade, rose 3.1%, down from 4.3% in the prior three months. Government spending picked up, expanding 3.3% after a 2.5% gain in the second quarter. Inflation as measured by the PCE price index, meanwhile, rose at a 1.6% annual rate in the third quarter, down from a 2% rate in the prior quarter. The core PCE price index rose at a 1.6% annual rate, down from a 2.1% rate in the second quarter.


The second quarter might have been the peak quarterly growth rate of this business cycle. We started the year with a tax cuts and that provided a temporary boost to start the year. Wall Street spiked at the beginning of the year, spiraled into a 10% correction and crawled back to a new high in September, before a sharp October selloff. No single factor explains the October selloff, but there are several concerns, including: rising interest rates, the gradual tightening of monetary policy, an intensifying trade war with China and some forecasts of lower corporate earnings on the horizon. Trump promised his tax cuts and deregulatory efforts would unleash a boom in business spending that would push growth rates above 3% or even 4%, indefinitely. Businesses were supposed to take the money they saved on their taxes and put up new factories, buy new equipment, and invest more in the ideas and technology of the future. Yet business spending decelerated in the third quarter, growing by just 0.8%. Such spending–known as nonresidential fixed investment–grew by 8.7% in the second quarter and 11.5% in the first quarter. That looks like a slowdown. Forecasting firms such as IHS Markit and Moody’s Analytics see overall growth slowing, not improving, in 2019 and 2020, with a recession possible. Business spending increases to meet demand. The tax cut proponents hoped for a jolt of stimulation that would push demand. It hasn’t happened. The market doesn’t believe 2019 growth is going to be anywhere near what it is expected to be.


The corporate tax cuts passed last December did stimulate the economy, but it appears to be not much more than a sugar high. The long-term strategy to reinvigorate the economy doesn’t look like it’s happening to any great degree — at least not yet. Tax cuts have not filtered down to individual workers’ paychecks. Wages are only rising 2.8% so far this year, which is roughly the rate of inflation.


Corporations have mostly returned their tax savings to shareholders in the form of share buybacks and dividends. Business investments may seem boring, but they are one of the keys to higher living standards in the future and higher profits. One thing we may be learning is that tax cuts don’t necessarily result in business investments. Without business investments, we won’t see higher productivity, without higher productivity we won’t see higher standards of living. And then there is the matter of timing; while the sugar high from tax cuts may be wearing off, we are also seeing the Federal Reserve hike interest rates and tighten monetary policy – a balancing act that would be tough enough without the fiscal stimulus component. Toss in trade wars and global slowdown and you have a highly uncertain environment for companies to consider investing. And don’t forget the dollar has been stronger. A widening gulf between the U.S. dollar and several foreign currencies is weighing on sentiment for U.S. companies trying to sell their goods overseas.  Anheuser-Busch, 3M, Illinois Tool Works, UPS and PPG Industries have specifically cited currency as negatively impacting results and their outlook.


The tax cuts, meanwhile, helped swell the government’s annual deficit by 17% in fiscal 2018, which ended in September, to $779 billion. The increase came mostly from a 31% decline in revenue from business taxes. Individuals, by contrast, paid more in income taxes in 2018, contributing to voter skepticism of the tax law. The last time the economy was this good, in the late 1990s, tax revenue surged, leading to four years of federal surpluses. The big problem is large deficits leave less room to stimulate the economy if – and when – economic growth slows.


The final reading of the University of Michigan’s consumer-sentiment index in October was 98.6, marginally below September’s level of 100.1. The initial reading was 99. Consumer sentiment remains fairly strong but does reflect stagnant wage growth.


Pending home sales edged up 0.5% to a reading of 104.6 in September from 104.1 in August. The National Association of Realtors index, which tracks real estate contract signings, snapped a four-month losing streak. But it was lower than year-ago levels for the ninth month in a row, this time by 1.0%. Contract signings usually precede closings by about 45 days, so the pending home sales release is considered a leading indicator for the existing-home sales report. Rising real mortgage rates and zero Y/Y growth in real average hourly earnings is not what builds strong housing markets.


Thursday was the busiest day of the third-quarter corporate earnings season, with giants such as Amazon and Alphabet reporting. Amazon shares plunged after revenue came in below Wall Street forecasts, while fourth-quarter guidance also disappointed. The company’s stock fell through its 200-day moving average, losing as much as 10 percent in after-hours trading. Google parent Alphabet also saw shares sink, after the tech company’s revenue also disappointed in the third quarter. Snap and Western Digital also saw shares fall, with the tech company continuing to lose money while the data storage company saw revenue come in below estimates. Shares of Intel, Mattel and Expedia all rose slightly but were not enough to outweigh the falling momentum from the biggest tech stocks.

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