While there have certainly been pockets of strength early into the third quarter earnings season, the overall tone has been largely negative, particularly as pertains to forward guidance. Pockets of weakness include industrials, autos, homebuilders, and consumer-related companies to name a few. Naturally, firms that serve these markets have been under pressure. One conclusion that can be drawn is that on a global basis, economic growth is slowing.
Is this the result of interest rate increases? Uncertainty surrounding trade and tariffs? Geopolitical concerns? The natural business cycles? Economic concerns impacting capital spending? The easy answer to these questions is all of the above.
Moreover, today’s market corrections, unlike past declines, feel sharper and much more volatile owing to a series of structural changes in the stock market since the early 2000’s. These changes include the end of the “up-tick rule”, making it easier to pressure stocks; the shift from specialist to electronic trading, less human intervention; high frequency trading, the rise of the machines; and the growth of ETFs (Exchange Traded Funds), when the indices go up or down the underlying stocks must also be bought or sold exacerbating any natural price moves.
Ultimately, equity prices are driven by the perception of future earnings or cash flows (the outlooks) and what investors are willing to pay today for those perceived streams (multiples/the discount rate/interest rates). It feels that we are at the maximum point of uncertainty about a number of these factors right now.
Clarity should come in the form of the upcoming US elections, along with some sense that Federal Reserve is really data dependent, rather than religious about rate increases. The resolution of these two issues will determine whether we will have suffered a garden variety correction or something more severe.