There’s a lot of unease in the stock market. But is it any wonder?
Volatility has increased. Interest rates have moved higher. Financial conditions have tightened. Investors are concerned about a potential slowdown in economic growth, the side effects of the latest round of tariffs and ongoing trade tensions, and the possibility the Federal Reserve might move too fast on interest rates and bring the economic boom to a stumbling end.
The Cboe Volatility Index® (VIX), which measures investors’ expectations of future stock market volatility, helps capture the mood. After a sedate summer and early fall, the “fear index” spiked in October as triple-digit swings in the Dow Jones Industrial Average returned after a long break. The VIX has since come down from its recent high and is actually closer to its long-term average now, but it is still almost double its level during the quietest part of the summer.
So what should investors expect in the coming months? While it’s impossible to say what surprises may come, two “seasons” of the market could point the way forward.
End of year rally?
One potential bright spot after the rough month we’ve just had is that we’re entering a traditionally more favorable season for stocks. “Novembers and Decembers of midterm election years have historically been quite strong,” says Liz Ann Sonders, Schwab’s chief investment strategist. And according to Ned Davis Research, in all years going back to 1952, November through January have been the best three months of any rolling 12-month period.
“Of course past performance is no guarantee of future results but it can be comforting to have some historical tailwinds,” she says.
And something good could still come from the wild swings the stock market experienced in October: Investor sentiment is no longer excessively optimistic, as it was earlier in the fall, according to the Ned Davis Research Crowd Sentiment Poll. Sentiment actually dipped into the extreme pessimism zone in the immediate aftermath of the October correction.
“Investor sentiment is generally a contrarian indicator, meaning when the crowd is going one way, the smart money goes the other, so the decline in sentiment could provide more near-term support for stocks and set the stage for further relief rallies,” says Liz Ann. “That said, we remain cautious about equities and continue to recommend investors take no risk beyond their longer-term strategic U.S. equity allocations.”
Unfortunately, corporate earnings season could pose other challenges in the months ahead.
“Earnings season has been strong as far as results go to this point, but as we often say: Better or worse matters more than good or bad. Are things good and improving, or good and about to get worse?” says Liz Ann.
Earnings growth rates have been stellar this year thanks, in part, to corporate tax cuts. They were 27% in the first quarter and 25% in the second quarter, according to Thomson Reuters. They are expected to rebound to 27% for the third quarter, but then weaken to 18% for the fourth quarter. Growth rates will likely get worse from there because year-over-year comparisons will grow decidedly less favorable as the effects of the tax cut at the end of 2017 start to fade—expectations for earnings growth in the first three quarters of 2019 are now well below 10%, according to Thomson Reuters.
A few other factors could be giving investors pause. First, tariff concerns are becoming an increasingly common feature of many corporate conference calls, according to FactSet data. At the same time, housing sales have been weakening in recent months. And there are some concerns the Fed might respond to the steady drop in unemployment and meaningful uptick in wage growth by becoming more aggressive with interest rate hikes.
Seasons in flux
The bottom line is that even with the approach of the historically upbeat end-of-the-year season, other pressures are likely to persist, which could mean more bouts of volatility and more frequent pullbacks.
“There will likely be more volatility, but at least overly optimistic investor sentiment has eased, U.S. economic growth remains solid and the midterm elections will soon be over, all of which could trigger at least a relief rally off the recent lows,” says Liz Ann. “But those other factors aren’t going away. Investors would do well to stay disciplined as the year winds down.”
What You Can Do Next
- Market volatility is unnerving, but it’s a normal—and normally short-lived—part of investing. If you’ve built a solid financial plan and a well-diversified portfolio, it’s best to ignore the noise and focus on your long-term goals. Want to talk about your portfolio? Call our investment professionals at 800-355-2162.
- Watch Schwab experts discuss other market and economic topics in the Stock Market Report.