October Stock Pullback Reflects Normal Volatility

By Kate Warne October 11, 2018

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Over the past week, worries about rising interest rates, heightened China trade tensions and other international risks have been weighing on stocks. Those worries escalated Wednesday (Oct. 10) and continued Thursday (Oct. 11), pushing the S&P 500 and Dow down more than 6.5% from their recent highs, and the TSX Index more than 7.5% from its 52 week high. As investors became more cautious, technology and other faster-growing stocks initially led the declines, and the Nasdaq was down about 10% from its August high, which is a correction. As investors reacted, other sectors also dropped more than the market averages. Keep in mind that historically, stocks have declined by 5% or more about three times a year, so this looks like normal volatility. We think the outlook remains positive, and the current dip doesn't seem unusual.

Higher Interest Rates Reflect Expectations for Solid Growth

The Federal Reserve has been slowly increasing short-term interest rates for more than two years, but long-term interest rates have risen less. Over the past week, rising long-term rates took the lead due to signs of better-than-expected economic growth, a solid job market and worries about higher inflation. Similarly in Canada, the 10-year GoC yields have also risen, despite recent economic headwinds, reaching their highest level since early 2014.

Economic indicators (such as the ISM services index) and the solid job market reflected in the 3.7% unemployment rate in the U.S., and 5.9% in Canada, a 40-year low, suggest an above-average pace of economic growth. In addition, the positive impacts of the tax cut and higher government spending continue. But inflation rose less than expected in September and is up only 2.3% in the U.S. over the past year, calming worries about faster-rising prices. Companies in the S&P 500 are expected to report third-quarter earnings up almost 20% over the past year, according to FactSet. Those positive fundamentals support our outlook for rising stock prices over time.

Higher tariffs and trade tensions are weighing modestly on global growth, and while we don't expect a trade war with China, we think negotiations will be slow and difficult. The strong U.S. dollar and slower-than-expected global growth meant international equities lagged U.S. stocks this year, and they also dropped recently in response to U.S. worries. But better valuations and solid prospects make international equities attractive, and performance tends to rotate over time. We recommend staying invested with an appropriate allocation to international equities.

Staying Invested When Markets Move

Bond prices generally move in the opposite direction from interest rates. Rising interest rates since the start of the year lowered the value of bonds in portfolios, which is one reason better-diversified portfolios haven't matched the gains in stocks. But as stocks declined recently, bond prices rebounded, helping stabilize the value of a diversified portfolio. Over time, better-diversified portfolios have been less volatile than owning just stocks, which can help you stay calm and invested when markets move sharply. That's why we think it's important to own the right mix of stocks and bonds based on your comfort with risk, financial goals and time horizon.

Although the specific triggers for a pullback are almost always unexpected, they happen regularly and are a part of normal market volatility. We don't think this time is different.

Important Information:

Diversification does not ensure a profit or protect against loss in a declining market.

Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal. Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

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