What's Driving The Stock Market Skid?

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by: Russell Investments

On the latest edition of Market Week in Review, Senior Investment Strategist Paul Eitelman and Consulting Director Sophie Antal Gilbert discussed the ongoing volatility in markets, the U.S. GDP growth rate for the third quarter and the European Central Bank's (ECB) plans for ending quantitative easing.

Market slump continues. Is earnings season to blame?

Global markets were battered the week of Oct. 22, Eitelman said, with the S&P 500® Index posting a weekly decline of roughly 4.5% as of midday Oct. 26, while the MSCI Emerging Markets Index and the Euro STOXX 600® Index both finished the week off roughly 3.5%. The U.S. in particular has taken the brunt of the current market downturn, Eitelman noted, with the S&P 500 briefly dipping into correction territory the morning of Oct. 26 - down approximately 10% from its all-time high on Sept. 20.

What's behind the market slump? "In our view, it boils down to third-quarter earnings season, especially in the U.S.," Eitelman stated. First off, while many companies are still beating expectations - overall earnings growth is roughly 23% so far, he noted - the number is a step down from the first and second quarters of 2018, when U.S. large-cap companies logged growth rates of approximately 25%. Secondly, the market appears to be latching on to disappointing news at the micro level from some company management teams, Eitelman said. "Amazon, for instance, reported revenue guidance for its critically important fourth-quarter holiday shopping season that was 5% below consensus expectations-and this resulted in a big headwind for the company's forward-looking outlook," he explained.

Eitelman is also seeing some anecdotal evidence that costs are starting to ramp up for U.S. businesses. "This presents a real question mark on the sustainability of profit margins for U.S. companies, which are currently at record levels," he noted. All things considered, though, Eitelman stressed that, in his opinion, the current backdrop does not point to the start of a bear market. "Ultimately, the downturn in markets is likely being caused by earnings expectations that were a little bit too high and a little bit too optimistic," he said, adding that he views the step down in sentiment as a healthy adjustment.

Q3 GDP shows continuing robust economy in U.S.

As proof that the U.S. economy remains strong, Eitelman pointed to the gross domestic product (GDP) growth rate for the third quarter, which came in at 3.5%, per the Commerce Department. "This is a really good number at this stage in the economic cycle," he observed, "and the strength really seems to be coming from consumer spending, which increased by 4%."

One slightly worrisome detail in the latest report concerns business investment, which grew by just 1% during the third quarter - a much slower increase than what was observed in the first and second quarters of the year, Eitelman said. "It's possible that this slowdown could mark the early signs of trade-related anxiety weighing on business conditions," he noted, adding that it's too early to draw any hard-and-fast conclusions at this stage.

Quantitative easing to end in December, ECB says

ECB President Mario Draghi announced Oct. 25 that the central bank will continue on a path to concluding its quantitative easing (QE) program at the end of the year, Eitelman said. "At the highest levels, we're seeing a significant healing in the European labor market, with a sharp drop in unemployment and strong consumer spending," he explained, "and amid this healthy fundamental backdrop, the ECB really can't sustain its super-accommodative monetary policies of the past."

More importantly for markets, in Eitelman's opinion, is that the ECB remains committed to low interest rates through the summer of 2019 - with the central bank leaving rates unchanged following its latest meeting. "This means European monetary policy will remain much more accommodative than in the U.S.-which we believe may be an important relative tailwind in favor of Europe going forward," he concluded.

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