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Volatility Strikes in October

US equity markets entered into correction territory this month as weakness in growth stocks, the tech sector, and certain cyclical stocks dragged down the equity market.

Further, the Q3 earnings season began to highlight rising costs for companies. These rising costs include a number of company inputs such as higher employee wages, material charges, and transport expenses.

Our Perspective
Many key market risks we highlighted last month negatively impacted markets in October. We believe market volatility will rise as the US economy approaches peak growth and moves further into late cycle territory.

Market volatility will rise as the US economy approaches peak growth and moves further into late cycle territory.

Along with peak growth, we might also expect peak profits. Not all companies will be able to pass higher costs onto customers, causing profit margins to shrink. Shrinking profit margins reduce company earnings and are becoming another rising threat to the overall market.

Oil Prices Sink

Crude oil prices hit 10-week lows near the end of October on growing concerns over demand and the economic outlook, as well as on news that Saudi Arabia will increase its crude production to 11 million bpd.

Our Perspective
Saudi Arabia, and also Russia, have both been very proactive in raising production well before the Iran sanctions kick in. Additionally, previous pushes by Saudi Arabia to reach 11 million bpd or higher have not gone well. If they can sustain that output level, it would build conviction that their spare capacity is real.

SEC Ruling Hits Stock Exchanges

Last month, the Securities and Exchange Commission (SEC) unanimously ruled against proposed market data fee increases by the stock exchanges. Market data is becoming a key part of the business for the major exchange groups such as Intercontinental Exchange (the parent of the NYSE) and CBOE Global Markets.

Our Perspective
Historically, the SEC has essentially rubberstamped fee increase requests. The decision is negative for several of the major exchanges and indicates that the exchanges will have less ability to raise prices going forward. Still, the impact should be mitigated. Data fees are a small portion of revenues and there will not be a cut to pricing.

JUUL Gets Inspected

The FDA seized thousands of pages of documents from upstart e-cigarette maker JUUL during a surprise inspection in early October. Although traditional cigarette usage is down among teenagers, e-cigarettes are up substantially. FDA Commissioner Scott Gottlieb recently describing teen use of nicotine vaping devices as an “epidemic”.

Within a few years, JUUL has captured a majority market share of e-cigarettes with its devices (called vaporizers) and its tobacco cartridges (dubbed JUUL Pods). The pods come in many sweet flavors such as mango and crème brûlée.

Our Perspective
The FDA’s end game is not yet clear. It is possible that the FDA’s biggest issue with the teen usage is how concentrated it has become with JUUL products and not necessarily with teen use as a whole.

Traditional tobacco companies do not direct advertising to kids and have well-established verification programs. JUUL has done little to prevent a growing and widespread social media presence.

We believe the FDA will fine JUUL, and they may cut teenage-friendly flavors as well. If the FDA eliminates sweet flavors or forces JUUL to suspend sales until they go through proper regulatory pathways, it could be a fatal blow.

Our View
Economic Cycle		Recent developments argue that stocks and bonds are entering a higher risk period over the next twelve months; US economy is moving in late cycle territory and showing signs of progressing down the path of a normal economic cycle; internationally, position in the cycle varies by country/region
Growth		While not calling for imminent recession, the US is approaching a period of peak growth; any further growth above long-run potential should lead to inflation pressures; today’s risk profile for economic growth is skewed to the downside
Inflation		Market pricing in subdued inflation environment; late cycle inflationary pressures may remain contained by demographics, fiscal policies and tax reform, ‘Amazon effect,’ and global debt levels
Interest Rates		While interest rates may level off in the short-term, tightening monetary policy across the globe supports interest rates moving higher; we expect another Fed rate hike this year and two more next year
Key Risks		Global risks are rising and notably include trade tensions, Chinese economic slowdown, greater geopolitical uncertainty, and rising costs (e.g., wages)
Equities		Expect global equity returns to be lackluster; valuations improved but still a headwind, with select pockets of opportunity in international markets; favor higher quality businesses, reasonably priced growth companies, and businesses with fewer embedded late cycle risks (e.g., leverage)
Fixed Income		Corporate bonds continue to adequately compensate investors on a fundamental basis; neutral US Treasury valuations; finding shorter-dated, high quality asset-backed securities attractive (credit cards and autos); prefer a modest duration and barbell maturity structure as we expect the yield curve to flatten

Indicates Change

Analysis: Manning & Napier Advisors, LLC (Manning & Napier).

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