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Is it Time to Panic About Stocks? This Indicator Says No

Written by Jason Stutman
Posted October 13, 2018 at 8:00PM

The trouble started on Wednesday...

Fueled by increasing interest rates, the Dow Jones Industrial Average tumbled 832 points (3.15%) to close at the lows of the day. The S&P 500 fared slightly worse, dipping 3.3% to close at 2,786.

Leading the market downward were technology shares. The tech-heavy Nasdaq Index gave up 4.08%.

Perhaps most dramatic were the share price performances of major tech names. Apple’s (NASDAQ: AAPL) shares fell almost 5%, and Jeff Bezos, thanks to Amazon’s (NASDAQ: AMZN) poor showing, shed over $9 billion off his net worth in just 6.5 hours of trading. Have a drink, Jeff.

Of course, Jeff Bezos wasn’t the only person to lose money this week. A lot of investors are also having a bit of a scare, but let’s be sure to keep things in context. After all, we’ve had one heck of a run over this record-long bull run...

Had you bought an S&P 500 index fund five years ago, in October 2013, you’d be up over 68% — 11% per year including dividends.

Even after this week’s drop, investors are still up over 280% since March 2009 (the Great Recession bottom) for an annualized return of 15%. That’s almost DOUBLE the market’s historic 8% long-term return.

An occasional pullback is to be expected and, arguably, is healthy.

Times have been particularly good since the day President Trump took office. The S&P 500 has handed investors a hefty 25% return, give or take, in the 21 months since.

The economy can be too good after all.

As for the trigger, the most common reason offered up for this week’s market-wide red ink was rising interest rates. Interest rates essentially act like gravity on financial assets — pulling them down as they rise.

And the bears have a point.

When the U.S. Federal Open Market Committee met on September 25th, it was decided that short-term interest rates (the rate at which the Fed willingly lends to financial institutions on a short-term basis) would rise yet again by 25 basis points. This marked the third time the Federal Reserve, now led by Trump-appointed Chairman Jerome Powell, has raised rates this year.

Why are these economists making mortgages more expensive behind closed doors? Because the economy continues to grow at a white-hot pace.

Recent economic data made the decision for them, with second quarter GDP readings showing a 4% annualized expansionary pace. That’s well ahead of the U.S. long-term average of about 3% and good enough to force the official unemployment rate down to a 17-year low of 3.9%.

Though it hasn’t happened just yet, there are signs that inflation (the inevitable by-product of fast growth and low interest rates) could rear its ugly head. September’s CPI (Consumer Price Index) reading rose 0.1% in September after rising 0.2% in August. For the 12 months ended September 30, consumer prices have risen 2.3%.

In effect, the Federal Reserve has to tap on the breaks to make the turn.

Rising rates, though, don’t automatically doom stocks.

Yes, higher rates make the main alternative to stocks, bonds, more attractive. And yes, rates do act like a wet towel on economic growth. But the real effect on stock prices is more nuanced. It depends on just how fast corporate profits are growing and where exactly rates are in relation to earnings yields. Interest rates rise during strong economies, which equals robust earnings growth.

Whether stocks rise or fall is more a balancing act than anything else.

In fact, in a recent study conducted by Vanguard, stocks fell in just ONE of the past 10 rising interest rate periods:

Period

S&P 500 Annualized Return

November 1967 – October 1969

3%

January 1972 – September 1973

6%

February 1974 – July 1974

-15%

December 1976 – April 1980

4%

July 1980 – December 1980

41%

January 1983 – August 1984

9%

December 1987 – April 1989

22%

March 1993 – April 1995

8%

June 1999 – July 2000

13%

June 2004 – July 2006

6%

According to FactSet, S&P 500 companies are expected to continue doing brisk business. Third quarter S&P 500 earnings are expected to rise 19.2% year over year — not bad at all. True, these bottom-line results are thanks largely in part to Trump’s $1.5 trillion tax cut package, but still, cash is cash.

Simply put, the sky is not falling, and there is no apparent economic indicator to suggest we’re entering any kind of recession that will hold down stock prices.

There’s an old saying on Wall Street that “market tops arrive when there’s no one left to buy.” Looking back on previous market tops, like the 2000 tech bubble, it just doesn’t seem like we’re “out of buyers” quite yet.

The current average P/E ratio of the S&P sits just above 22. That’s high, but it’s nowhere near the 32.92 P/E ratio of 1999 (we won’t even go near the multiple on the Nasdaq back then).

Is it possible we’re about to enter a bear market? Well, investors should always be prepared for anything.

But what’s more likely is that this past week was a healthy pullback. Stock prices have had a heck of a run, and the occasional breather should be expected.

Just remember, no matter what happens, there’s always a bull market somewhere. All you need to know is where to look.

Until next time,

  JS Sig

Jason Stutman

follow basic @JasonStutman on Twitter

Jason Stutman is Wealth Daily's senior technology analyst and editor of investment advisory newsletters Technology and Opportunity and The Cutting Edge. His strategy for building winning portfolios is simple: Buy the disruptor, sell the disrupted.

Covering the broad sector of technology and occasionally dabbling in the political sphere, Jason has written hundreds of articles spanning topics from consumer electronics and development stage biotechnology to political forecasting and social commentary.

Outside the office Jason is a lover of science fiction and the outdoors, and an amateur squash player at best. He writes through the lens of a futurist, free market advocate, and fiscal conservative. Jason currently hails from Baltimore, Maryland, with roots in the great state of New York.

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