Markets

WEEKLY FOCUS - Portfolio diversification with innovative tools                                                 29 October 2018

Half of the companies within the S&P500 have now reported earnings and data from Factset shows a blended growth rate of 22.5%, the third highest since Q3 2010. The US GDP number for Q3 reported last week beat analysts’ expectations at 3.5% annual rate as consumer spending remained resilient and the deflator was a tailwind. Yet as of last Friday’s close, the performance of major equity indices for the year to date are in the red and the S&P500 suffered a drop of 10% from its recent all-time highs. Furthermore, in spite of positive EPS surprises, the related reaction in average price change has been negative and at its lowest level since Q3 2011 (see chart above). To illustrate this, as of last Friday, the 21 day standard deviation of over half of stocks on our watch list is above 1 sigma.

So what is actually causing sentiment to become negative? There are a confluence of factors starting with the ratio of negative to positive EPS guidance for the S&P500 for Q4 which is, as of last Friday, 1.73. It is also due to monetary policy which has become more hawkish in the US as economic growth accelerates and fiscal policy expands. In Europe, the manufacturing PMI data which has a strong correlation to GDP growth shows no signs of rebound yet causing Mario Draghi, the ECB President to implicitly acknowledge last week that policy would remain accommodative and hence impact the Eurodollar due to policy asymmetry. Lastly, based on business surveys from the Federal Reserve, it appears that US businesses are facing higher input costs from the trade war situation and suffer the effects of retaliatory tariffs, especially on farm products.

The catalysts for markets to go up or down from here are uncertain as sentiment can dictate direction. Hence it makes sense, not only to be diversified, but also to explore exposure to other financial instruments that allow investors to benefit whatever the direction of markets if certain parameters are met.