US Markets were exceptionally calm and consistently positive this summer, breaking out to new highs while tacking on +7.2% to the S&P 500 US Large-Cap index (‘SPY’ ETF Proxy*), leaving it up +10.4% for the year. Bullishly, growth and technology issues performed better still. The only apparent crack in the foundation for the quarter was a widening performance gap between domestic and overseas stocks.

Foreign stocks struggled against a strong US Dollar, political disruptions, and signs of moderating global growth. Chinese stocks were particularly hard hit. In combination with headwinds to the bond complex in the face of rising rates, 2018 looked to be a “one-trick pony” year, with only US stocks pulling their weight followed by commodities as a close second. Of course, that rather contented narrative ended the second trading day of October, and this quarterly recap has been rewriting itself ever since. As of mid-October, major global stock indices are down significantly on the month. Why the sudden change of fortune?

Answer – it was likely a mix of factors all coming to a head at once. The International Monetary Fund reduced its global growth outlook based on expected tariff impacts; Hurricane Michael hit shore at full Category 4 strength; rumors of a pending Sears bankruptcy circulated; US treasuries exploded higher on inflation fears together with commentary from Federal Reserve Chairman Powell stating more rate increases may be necessary to reach a “neutral state”; oil moved higher on Iranian news; and, Italian budgetary discord and Brexit uncertainty continued to loom, as do US mid-term elections. As selling accelerated, it is also likely that leveraged buyers were motivated to sell their prior winners, and that algorithmic trading contributed to the down-trend.

And yet, the US economic backdrop remains quite robust. Real Gross Domestic Product for the second quarter came in at +4.2% (Bureau of Economic Analysis). Unemployment also hit its lowest level since 1969 (Washington Post, “Unemployment rate falls to 3.7%,” 10/5/18). Finally, while we are monitoring the potential impact of tariffs, currency effects and hurricane damage, our primary focus is on upcoming earnings. US Earnings are expected to log a third consecutive +20% year-over-year increase (Factset, “S&P 500 Likely to Report Growth Above 20%,” 10/5/18). As during the first quarter correction, it would be extremely rare for a full bear market to evolve against such a strong economic backdrop.

In this context, for now we expect volatility to be transitory, possibly setting up for a decent year-end rally. In any event, investors in The Encompass Portfolios may take comfort from our moderate cash position coming into the choppiness, and the knowledge that the portfolios are designed to adjust to changing dynamics, whatever markets bring our way.

* Not Individual Investment Advice; Dividend-adjusted proxy ETP data from Commodity Systems, Inc. & Allocations as of September 30, 2018; ECA assumes no duty to update any information in this presentation for subsequent changes of any kind.