A Two-Day Tumble for Stocks

By Victor Zhang - October 11, 2018

Stocks were battered in two days of volatile trading amid growing concerns that rising interest rates, higher costs, and trade tensions would squeeze corporate profits. Technology shares led global markets lower on Wednesday while energy stocks were among the biggest losers amid lower crude oil prices on Thursday.

U.S. stocks were hit hardest during the last two trading sessions with the S&P 500® Index falling 5.28 percent and the Dow Jones Industrial Average falling 5.21 percent. The tech-heavy NASDAQ also dropped, falling 5.29 percent. International developed markets were caught in the downdraft with the MSCI EAFE Index shedding 2.73 percent of its value. The last two days also put further pressure on battered emerging markets as the MSCI Emerging Markets Index fell 3.96 percent.

The sell-off has been widespread, with few areas of the market escaping unscathed. Defensive, dividend-paying sectors, including utilities and consumer staples, fared better than others.

On the surface, the stock market sell-off is not a reflection of weak economic data. As we recently reported, U.S. economic growth, employment and wage data remain robust. Furthermore, business and consumer confidence measures are high, and third-quarter corporate earnings for S&P 500 Index companies are on track to post a record-setting 28% year-over-year gain.

But along with these favorable influences, investors are coming to grips with some challenging factors.

Rising Interest Rates Are a Key Culprit

The robust U.S. economic data, combined with the Federal Reserve's (Fed's) ongoing tightening strategy, have caused U.S. interest rates to rapidly rise. At the same time, wage growth and higher input costs suggest inflation pressures may be building, though Thursday's reading on U.S. consumer prices came in lower than expected. For nearly a decade, technology companies and other fast-growing businesses have fueled their record earnings growth amid a backdrop of ultra-low interest rates and muted inflation. And now the landscape is changing.

Investors fear higher interest rates will cut into corporate profit margins. In addition, stock investors view rising Treasury yields as a threat, because higher fixed-income interest payments may become more appealing than stock dividends.

Global Factors Weighing on Sentiment

In retrospect, we saw signs of the two-day sell-off when key global industrials companies fell hard due to profit warnings. On top of higher borrowing costs, these companies indicated higher labor and materials expenses, slowing demand from China, and the still-strong U.S. dollar may cut into operating results. Investors fear these factors, combined with escalating U.S.-China trade war rhetoric and political instability in Italy and other emerging markets countries, may have implications for a broader range of global companies.

In addition, the credit markets—which have generally remained stable—have flashed warning signs. Outflows from U.S. high-yield bonds topped $5 billion this week. This marked the largest outflow since February, when $6.3 billion exited the market. The February drawdown was the second-largest on record. However, other credit securities, including floating-rate bonds and loans, continued to attract investor attention and outperform rate-sensitive fixed-income securities.

Short-Term Volatility Merits Longer-Term Focus

In our view, the U.S. economy remains on solid ground. Employment and growth data are strong, corporate fundamentals remain sound, and we believe investors should continue to reward companies exhibiting earnings growth.

Although we expect Treasury yields to eventually consolidate near current levels, we also believe there is potential for an overshoot in the short-term. From a technical perspective, a combination of waning reinvestment from the Fed (due to its balance sheet cuts) and a meaningful increase in upcoming Treasury issuance should keep U.S. rates under pressure, as long as the economic data remain robust. This influence, combined with tariffs, a slowdown in China, and other factors weighing on stocks, likely will contribute to heightened volatility in the near term.

As always, we encourage investors to stick to their long-term investment programs rather than react to short-term market volatility.

Victor Zhang
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      The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

      This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.