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831 Point Drop in the Dow (3.1%) - October 11, 2018

The fundamentals really do matter (until they don't).

1. The economy is expanding at a solid pace; recent data have been strong.
2. Q1 and Q2 profits were strong and Q3 is looking very upbeat
3. Inflation isn't showing signs of accelerating.
4. Interest rates remain low (10-year Treasury at levels not seen since the late 1950s, excluding recent years).


Absent of risk, fundamentals can determine the short-term direction of shares. When new risks surface, the fundamentals may not matter short term, though they still influence the medium and longer-term direction of shares.

Short-term, new risks can jump to the front burner and short-term traders react - shoot first, don't ask questions...then shoot the messenger.


A delayed reaction?

"The really extremely accommodative low interest rates that we needed when the economy was quite weak, we don't need those anymore. They're not appropriate anymore," Fed Chief Jerome Powell said on Oct 3 in a PBS Q&A with Judy Woodruff (CNBC).

"Interest rates are still acommodative, but we're gradually moving to a place where they will be neutral," he added. "We may go past neutral, butwe're a long way from neutral at this point (my emphasis), probably."

The 10-year Treasury jumped 10bp to 3.15% that day and his remarks appear to be creating delayed jitters in stocks. Moreover, there may be some concerns the Fed could raise rates too high, which could end the economic expansion. Meanwhile, most companies are in a blackout period which prevents them from repurchasing their own shares in front of earnings reports. 

Still, much of the breakdown today was technical in nature, in my view. Yes, some may be a revaluation based on rising Treasury yields. And there are international concerns. But, once selling begins, selling can beget selling, which begets selling, and it continues until the closing bell.

One day result - ugly. Bigger picture - the S&P 500 is down 5% from its Sept 20 high, including 3.3% today. I should add, 5% selloffs aren't unusual. 


Thoughts
We've seen declines like this before; in recent years, we've seen worse. Historically, pullbacks in the context of a healthy economy have not marked the end of a bull market.

Yes, it's late in the cycle, but the economy isn't faltering as it was in late 2000 and in 2008.

The yield curve (10 yr- 2 yr) has not inverted. Looking at inversions going back to the late 1970s, the S&P 500 peaked an average of 17 months AFTER the curve inverted, with an average increase of 24% following inversion (Disclaimer: past performance is no guarantee of future performance) - St. Louis Fed data, NBER.

Bear markets typically correlate closely with recessions. Short term, the data are not signaling a recession. 
 

@LWMLLC