Key Points

  • Equities have rallied off the lows but the issues contributing to the recent volatility are unlikely to dissipate in the near future. Ongoing risks keep us cautious and we continue to recommend that investors pare back risk if their equity holdings are above longer-term strategic allocations.

  • Economic and earnings growth rates may be peaking, while the labor market continues to tighten. This mix contributes to higher wage growth, possibly higher inflation and related uncertainty with regard to Fed policy. Midterm election uncertainty is gone, but partisan wrangling will likely persist.

  • U.S. midterm result may have a positive impact on international markets, but there are many other risks which keeps our outlook cautious.

“Divide each difficulty into as many parts as is feasible and necessary to resolve it”
- René Descartes

Much action, little resolution

U.S. stocks have been on a wild ride lately, with major indexes hitting correction (-10%) territory in October before bouncing sharply, albeit still below September’s highs. The internal health of the rally off the recent lows has not been impressive. While stocks were “oversold” at the late-October lows—and investor sentiment had moved from excessive optimism to pessimism—there wasn’t quite the type of panic selling and investor despair that often serves as a sign of a firm bottom. Fundamentally, the major issues which contributed to the correction—the trade dispute with China, geopolitical uncertainty, tightening financial conditions, and concern over the future of Fed policy—remain in play. We expect ongoing bouts of volatility and a wider trading range heading into 2019. The potentially-good news is that seasonality is now in the bulls’ favor. In the one year following all midterm elections in the post-WWII era, the S&P 500 was up every time (Stategas Research Partners)—albeit not without plenty of drama at times, like the Crash of ’87, which came within a year of the 1986 midterms. We continue to recommend that investors use volatility to rebalance back toward longer-term strategic allocations in order to keep excess risk at a minimum.

Another reason for optimism that the secular bull market is not dead is that stocks did not experience a blow off top before the latest correction, which is often how bull markets end. Interestingly, according to BCA Research, if bull markets were historically divided into time deciles, the first and last deciles were by far the best performers. This is yet another argument against trying to time the market with all-or-nothing moves. If you missed the first tenth or the last tenth of a bull market, historically your returns would have suffered. Past performance is no guarantee of future performance of course, but it can help to inform our decision making.