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IWM Monthly Commentary – October 2018


October once again worked its black magic on world markets, pushing major indices into negative territory for the year and fanning concern that history’s longest bull market may finally be extinguishing itself. The Federal Reserve Bank held steady to its tighter-money rubric despite mixed signals from the markets and some industries. The US economy, meanwhile, continued to grow at robust levels and unemployment rates remain at their lowest in generations.

Otherwise, global growth seems to have peeked—at least according to the International Monetary Fund—as Europe, emerging markets and China continued to struggle with rising interest rates and reduced demand. As the year lurches to a close, the fallout from US-led trade feuds had not been clarified.



Stocks took a beating in October as the Dow Jones, Standard & Poor’s and Nasdaq indices shed 6%, 7% and 9% for the month, respectively. Of the 500 stocks in the S&P 500, nearly 400 saw declines.

Among the high-profile casualties was BlackRock’s Larry Fink who, on October 16, lamented he was “not particularly happy” in response to a mass exodus of some $24.8 billion from the bank’s products. Fink tried to downplay the blood-letting as an overreaction by institutions to the slowdown in global growth and trade war concerns, while one analyst attributed the weakness to “industry-wide de-risking.”

FactSet Research reported that, with 48% of the companies in the S&P 500 reporting results for the third quarter, 77% of companies have reported a positive EPS surprise. The blended earnings growth rate for the S&P 500 was on track for 22.5% average growth for the quarter, which would mark the third highest earnings growth since Q3 2010.

At the same time, FactSet and Bank of America revealed that companies that reported positive quarter earnings surprises were punished by the market—their stock prices decreased by an average of 0.5% two days before the earnings release through two days after the release. At the same time, companies that reported negative earnings surprises for the quarter experienced an average price decrease of 3.5%, two days before the earnings release through two days afterward. While such penalties are hardly surprising, the lack of rewards for earnings per share and sales beats is common in the latter periods of late-stage bull markets. Or, as BofA strategist Savita Subramanian put it, “This suggests that the good news is priced in.”

On the fixed-income side, US Treasury yields tumbled in late October due to a decline in inflation expectations—despite a 25% surge in oil prices—and a quest for safe havens amid plunging stock prices. Such maneuvering, according to ZeroHedge, was in sympathy with a sinking University of Michigan inflation outlook to record lows and a Bloomberg report that the five-year breakeven rate, which represents bond investors’ view on the annual inflation rate through 2023, dropped Friday to 1.88%, the lowest since January of this year.

“The Fed may have entered restrictive territory by a full quarter-point hike,” ZeroHedge wrote, adding “inflation and growth expectations reflected in commodity prices suggest that 10Y Treasury yields should be dramatically lower from here.”

The ZeroHedge note followed a warning from JPMorgan Asset Management that spikes in volatility may spook investors into boosting allocation to bonds to cushion their portfolio amid mounting risks to global growth.

“It’s going to be so useful if things start to get out of control,” Kerry Craig, a global markets strategist at JPMorgan Asset Management, said at a briefing. “Think about the drag that driving with your handbrake creates, and that’s what bond markets are viewed as at the moment.”

The burden of servicing the US budget nearly doubled in October, to $779 Billion, an alltime high. The increase, attributed largely to tax cuts and defense outlays, was on track to reach $895 billion in November—$222 billion or 39% more than the previous year. Meanwhile, the US federal debt increased by $1.80 trillion in fiscal year 2018, according to data released by the Treasury Department. The figure marks the eighth fiscal year in the last eleven in which the debt increased by at least one trillion dollars and was the sixth largest fiscal-year debt increase in US history. The national debt now totals $21.50 trillion and counting.

Despite concerns about the rising cost of money, a recent report showed that investors have the lowest amount of cash in their investment accounts in this bull market, according to Real Investment Advice. “Individual investors drew down cash balances at brokerage accounts to record lows as the S&P 500 surged. For example, cash as a percentage of assets among Charles Schwab Corp. clients in August fell to 10.4 percent, matching the level in January that marked the lowest since at least 2004.”



The Bureau of Labor Statistics announced that October payrolls soared by 250,000, just shy of the highest Wall Street estimate and more than double last month’s downward revised 118,000. At the same time, August was revised up from 270,000 to 286,000. After revisions, job gains have averaged 218,000 over the past 3 months.

What’s more, the economy expanded at a 3.5% pace in the third quarter thanks to consumer spending, restocking of businesses inventories and governments expenditures, marking the strongest back-to-back quarters of growth since 2014, according to the Commerce Department.

Consumer spending, which accounts for about 70% of the economy, unexpectedly accelerated by 4%—the strongest showing since 2014—while the 0.8% gain in nonresidential business investment was the weakest in almost two years. Inventories provided the biggest contribution since early 2015, while the drag from trade duties was the largest in 33 years. Government spending rose by the most since 2016, while personal
income rose by just 0.2% month-on-month versus 0.4% for August and expectations of a 0.4% rise.

The Conference Board Consumer Confidence Index® increased again in October, following a modest improvement in the previous month. The Index stood at 137.9, up from 135.3 in September. In contrast, the University of Michigan sentiment survey weakened modestly to its final print of 98.6. Optimism among low-income Americans tumbled, the survey reported, and increases in home and vehicle prices, rising interest rates, and decreases in the pace of growth in inflation-adjusted incomes have especially dimmed prospects for home and vehicle sales.

The housing market, a key source of growth, continued to deteriorate. Home-price gains slowed in August to the slowest pace since 2016, as high borrowing costs and property values limit buyer interest, according to S&P CoreLogic Case-Shiller. The National Association of Realtors reported that existing-home sales fell 3.4% from August to a seasonally adjusted rate of $5.15 million in September. The median existing-home price for
all housing types in September was $258,100, up 4.2% from September 2017, marking the 79th straight month of year-over-year gains.

In response, Lawrence Yun, NAR chief economist, said rising interest rates have led to a decline in sales across all regions of the country. “This is the lowest existing home sales level since November 2015,” he said, adding that “decade’s high” mortgage rates are preventing consumers from making quick decisions on home purchases.

American US Manufacturing and Services PMIs surprised on the upside in the Flash October prints as the Composite Output Index, Services Business Activity and Manufacturing PMI scored highs of 3-months, 2-months and 5-months, respectively.

Inflation was a challenge, however. The cost inflation accelerated to its sharpest since September 2013 due to trade tariffs as well as rising fuel bills and higher borrowing costs. At the same time, factory gate charges continued to increase at one of the fastest rates since the first half of 2011.



The IMF issued its report on global growth downgrades led by China, which is expected to slow by 20bps to 6.2%. Emerging market and developing economies’ growth was downgraded 20bps and 40bps in 2018 and 2019, respectively, as the report warned that growth in major economies has peaked.

Growth in the eurozone, meanwhile, fell to its slowest pace in more than four years, according to Bloomberg. Following a rally sparked after Moody’s cut Italian debt ratings less than the markets feared (one notch above junk—Baa3), the euro weakened on the news that German business activity slowed to its lowest rate in nearly four years as France’s manufacturing PMI index hit a 25-month low.

The Bank of Japan held interest rates at -0.1% while trimming its inflation forecasts. It also vowed to purchase 10-year Japanese government bonds to maintain the yield at “around zero percent.” In doing so, Tokyo will drift further behind the rest of the developed world in policy normalizing in its battle to stoke inflation in line with its 2% target.

China was obligated to concede that its economy is slowing at a faster pace than recent forecasts after the National Bureau of Statistics reported that China’s manufacturing PMI fell to 50.2 in October—down from 50.8 in September and below estimates of 50.6. According to ZeroHedge, it was also the lowest number since July 2016 with almost all sub indexes showing weaker growth momentum. The NBS non-manufacturing PMI also missed, printing at 53.9 and declining from 54.9 due to the weaker services PMI.

David Young, CFA®
Chief Investment Officer, IWM, LLC
Brent Pine, CFP®, CPA
President & CEO, IWM, LLC
(480) 663-6000 (p)
(480) 663-6033 (f)
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Scottsdale, AZ 85251

*David Young is not affiliated with Geneos Wealth Management, Inc. Securities offered through Geneos Wealth Management, Inc. Member FINRA SIPC. Advisory services offered through Integrated Wealth Management, LLC.

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