Since the beginning of October global stock indexes have entered into what appears to be a normal correction. Broad indexes are down 3-5%, while higher beta (more volatile) indexes like the NASDAQ are closer to 6-7%. Most of the recent declines have come on the heels of an abrupt rise in interest rates just after the first of the month. As media news swirls with negative commentary about declining stock prices, higher interest rates and the “ides of October’s past,” we thought we would share a few important facts about today’s business and market cycle.

The Robust Economy
The global economy has been growing at a pace most investors had only wished for a few years ago. This has created strong fundamentals such as low unemployment and strong corporate profit growth – the primary driver of higher stock prices. In recent weeks the media and market prognosticators have suggested that the recent rise in interest rates will bring the economy to a screeching halt. This is just not so. However, as economies grow throughout a cycle, investors should be aware that the momentum of future economic growth may not be sustainable. Similar to a large ship that reaches cruising speed, the possibility of going much faster becomes difficult. In the same spirit, the likelihood of a significant deceleration or stalling of growth becomes nearly impossible at this rate of speed. The economy is doing just fine at this stage and investors should remain confident.

The Stock Market and October
The recent “pullback” in stocks is well within the normal range of past corrections. Moreover, keep in mind that today’s stock market is not overvalued at a price to earnings ratio of just 17. As you may be aware from our long history of Strategy Updates, a normal stock market correction within a bull market is 8-10%, and as mentioned above we are not even close to these figures. We understand that investors have been spoiled by a few years of little or no downside volatility and that these declines might take some getting used to. We are here to remind all that so far this is within the confines of normal – as would be a further decline. None of this recent market action should cause one to consider that the bull market has reached its end or that it has even lost its luster. In fact, market corrections of 8-10% are healthy for the longevity of the cycle. Lastly, we want to remind investors that though history is full of Octobers and bad stock markets, it is also full Novembers, Decembers and the rest of the year’s months!  The market does not know what time, week, or month it is and it trades on economic and corporate profit fundamentals – all of which at this point are very sound.

Interest Rates
A rise in interest rates has coincided with every robust economy and bull market over the last 100 years, so it should be of no surprise that rates are climbing. This is great news for those of us that invest in individual bonds as we can lock in higher rates along the way.  Investors should realize that we are coming off a decade of historically low rates and that the recent rise will not kill the economy or stock market.  The Federal Reserve is trying to make interest rates more “normal” which will mean further rate hikes are in our future.

As you know we are very mindful that a normal correction can eventually turn into something worse.  Therefore, we use a number of risk management tools to mitigate this risk which include your portfolio’s asset allocation, sector management and the use of carefully placed stop loss orders.  All of these tools are meant to mitigate the risk of catastrophic loss, while allowing you to “put up” with the volatility we have experienced as of late.

We hope you find this short update helpful.

Your Team at Main Street Research