Executive Summary:

• Domestic equities decline meaningfully
• Global markets generally fare worse
• Equity markets repricing after rates rise

Let’s dispel some topical misperceptions regarding last week’s sell-off in the domestic equity markets.

1. Tech stocks took the brunt of the hit.

Not true. The S&P Information Technology sector declined 3.82% which was in the middle of the pack for sector performance last week. In fact, the technology heavy NASDAQ outperformed the Dow and the S&P 500 for the week; respective performance was -3.74%, -4.19%, and -4.10%.

2. We are entering a period with rotation out of growth stocks into value stocks.

Really? The S&P 500 Citigroup Growth index outperformed the S&P 500 Citigroup Value index last week -3.92% versus -4.33%. The outperformance gap of Growth stocks over Value stocks is around 1200 basis points (12%) year-to-date.

3. The FAANG stocks are in “.com bubble” territory.

Don’t think so. Per Barron’s (10.15.18 page 16) here are valuation metrics, specifically 2019 forward P/E ratios a week ago versus last week’s close Friday:

• Facebook 22.7x versus 17.5x
• Apple 14.4x versus 16.2x
• Amazon 68.1x versus 56.3x
• Netflix 79.6x versus 80.8x
• Alphabet 20.1x versus 21.1x
• NASDAQ Composite 18.8 versus 19.6

Amazon and Netflix are high, they always have been. In fact, Amazon only within the last few years has had a positive P/E ratio because they only recently became profitable. We are investors of Amazon, Apple, and Alphabet. We would argue that the P/E ratios on these stocks aren’t unreasonable given their growth rates. Finally, at the height of the .com bubble the NASDAQ Composite had a P/E ratio of around 150x.

In our view, there has been no material change in economic data or the contentious global trade situation. Economic growth has picked up and inflation remains benign for now. No big surprises occurred when the big banks reported Q3 earnings Friday. Consequently, we come back to the run up in long term Treasury yields as the cause of the market swoon last week. As stated previously the rate rise is acknowledgement of a growing economy – how is this bad? The re-pricing of equities is normal in our view as rates are the discounting mechanism in determining equity prices. Higher rates imply lower stock prices in theory. Finally, is the Federal Reserve too aggressive with their plans for additional hikes in short term rates. We don’t know but would argue that the current paranoia in the capital markets is overdone. We remain at relatively low interest rates within the context of modern history. We continue to believe that the bias is for domestic equities to move higher through year end. And by the way, the yield on the benchmark 10-year Treasury declined last week.

The economic calendar for next week includes: retail sales data for September released Monday by the Census Bureau; industrial production data for September is released by the Fed on Tuesday; the Census Bureau releases new residential construction data for September on Wednesday. Leading economic indicators are reported by the Conference Board on Thursday; and, existing home sales for September is reported Friday by the National Association of Realtors.

Earnings season is upon us as Q3 earnings releases commenced Friday with large banks reporting. Next week is chock full of financial and the biggest blue-chip companies reporting.

• Monday – Bank of America
• Tuesday – Goldman Sachs, IBM, JNJ, Morgan Stanley, Netflix, and UnitedHealth Group
• Wednesday – Abbott Labs, Northern Trust, and U.S. Bancorp
• Thursday – American Express, Bank of New York Mellon, PayPal, and Philip Morris
• Friday – Honeywell, Kansas City Southern, P&G, and Schlumberger

Indices for the week and YTD are as follows:

• S & P 500 down 4.10% for the week; YTD index return is 3.50%
• NASDAQ Composite down 3.74% for the week; YTD index return is 8.60%
• Dow Jones Industrial Average down 4.19% for the week; YTD index return is 2.51%
• Benchmark 10-year Treasury bond yield stands at 3.14% - down 8 basis points on the week