Equities declined sharply as the IMF cut its outlook for global growth and German industrial production fell, the biggest decline since 2009. Selling accelerated late in the afternoon after several moving average lines were violated. In my view, the proverbial machines co-opted trading once these levels were crossed.
Are the large caps finally capitulating and playing catch up with the rest of the market for according to Bloomberg the typical stock has already declined about 25% from it early summer apex?
The basis for the IMF reduced forecast is geopolitical tensions, the major reason for the sharp drop for Germany decline in manufactured goods, as well as financial market “froth.” The IMF did not mention what markets were “frothy.”
The IMF downgraded the expected global growth rate to 3.8% from 4.0% expected in July but increased the US anticipated pace to 2.2% from 1.7% projected in July.
If this forecast does come to fruition, the smaller capitalized issues should outperform given their sensitivity to revenue gains and interest rates, the same issues that have been crushed since July. As widely discussed the Russell 2000 is down about 11% from its early July apex because of interest rate and revenue fears.
According to Bloomberg the Russell 2000 is trading at 18.6x trailing and 17.1x anticipated earnings. Historically this small cap index trades around 21x profits. Ifrevenues and earnings exceed estimates, and if there is no major change in interest rates, I can argue the Russell 2000 can easily out perform all other indices. If the IMF American growth forecast materializes, I will argue the odds of over performance is greater than 65%.
Speaking of earnings and interest rates, today the Minutes from the September FOMC meeting is released. Third quarter earnings season also commences. How will these events be interpreted? Perhaps the only concrete statement to write the interpretation will depend upon one’s preconceived bias.
Commenting further on earnings, I think most will look for comments regarding how the rising value of the dollar is impacting sales and profits. Attention may also be focused upon the impact of today’s geopolitical tensions. To reiterate approximately half of the S & P 500 revenues and profits are from global trade.
Treasuries on the other hand rallied significantly pushing yields to the lowest level since May 2013. I ask is there a disconnect? The IMF increased the growth outlook in the US by 50 basis points or by 29% and reduced the global forecast by 20 basis points or by 5%. The US economy is about three times the size of the next largest economy.
I ask is not the increase in domestic output more significant than a minor downgrade in the global output?
What will happen today? As noted earlier, the Minutes from the September FOMC meeting are released at 2:00 and third quarter earnings season commences after the market closes.
Last night the foreign markets were down. London was down 0.21%, Paris down 0.26% and Frankfurt down 0.33%. Japan was down 1.19% and Hang Sang down 0.68%.
The Dow should open nominally higher ahead of the FOMC Minutes that may offer some clarity about global growth and interest rate outlook. The 10-year is off 3/32 to yield 2.35%.