Following very strong third quarter stock market returns, volatility in October has picked up significantly, culminating this week with a correction that caused the S&P 500 to move into negative territory for the year. Given the severity of the sell-off, (down 10% since late September) as well as the significant daily volatility, we thought you might appreciate hearing our thoughts.

When we formulate our investment outlook, we turn to economic data and corporate earnings growth trends to guide our view. Even though we are in the tenth year of this economic cycle, GDP growth is very healthy. Third quarter GDP was just reported and showed that consumption, a driver of 70% of GDP, grew at an impressive 4% pace which bodes well for the upcoming holiday season and is a clear sign that the economy is strong. Thus far roughly one third of the S&P 500 has reported third quarter earnings. Despite headlines suggesting the contrary, earnings results have generally been at, or above, expectations and quarterly earnings are on track to grow at a 22% pace. Furthermore, while corporate earnings growth has been positively impacted by lower tax rates this year, revenue growth trends have also been stronger than usual and, thus far this year, have been expanding at a 10% pace. This gives us confidence that fundamentals continue to be very healthy.

However, market corrections can happen when uncertainty begins to overwhelm positive fundamentals, and this appears to be what is happening now. Global trade tensions, particularly between the U.S. and China, have continued to escalate and political uncertainty is heightened due to the upcoming midterm elections. Additionally, the severity of the financial crisis has still not been forgotten and investors seem to be on heightened alert for any signs of economic slowing. As an example, a recent move higher in interest rates led to concerns that the Federal Reserve is acting too quickly and that the economy could slow as a result. In reality, the Federal Funds rate is now at 2.00-2.25%, a level that is still quite low compared to historical averages. When taking inflation of 2% into account, real rates are still close to zero.

Over the next month, some of this uncertainty may be alleviated as the outcome of the midterm elections will be known and more progress toward a middle ground between the U.S. and China may be made at the upcoming G20 meeting. Additionally, the majority of third quarter corporate earnings will have been reported, giving us a solid glimpse into current business trends. Once third quarter earnings are out of the way, companies will once again be able to buy back shares, which should also provide support to the market. In our view, the most likely scenario is that these risks will be overwhelmed by the positive fundamental backdrop continuing to prevail.

Given our assessment of the current environment, we considered this market pullback to be a good buying opportunity and added additional exposure to U.S. large cap stocks to your portfolio. We also added a position in a new mutual fund that invests in emerging market government bonds. This is an area that is trading near its historical valuation lows at a time when most emerging market countries are in much better financial health than they were several years ago. In our view, maintaining diversified portfolios and having the discipline to take advantage of market corrections contribute to a successful long-term investment outcome. As always, we are happy to discuss our view with you in more detail and welcome your phone calls and in-person meetings in the coming weeks.

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The above commentary has been developed internally and/or obtained from sources which Sand Hill Global Advisors, LLC (“SHGA”), believes to be reliable; however, SHGA does not guarantee the accuracy, adequacy or completeness of such information nor do we guarantee the appropriateness of any investment approach or security referred to for any particular investor.  This material is provided for informational purposes only and is not advice or a recommendation for the purchase or sale of any security.  This information reflects subjective judgments and assumptions, and unexpected events may occur.  Therefore, there can be no assurance that developments will transpire as forecasted.  This material is informational and may or may not reflect the opinion of SHGA on the date made and is subject to change at any time without notice.  SHGA has no obligation to update this material.  We do not suggest that any strategy described herein is applicable to every client of or portfolio managed by SHGA.  In preparing this material, SHGA has not taken into account the investment objectives, financial situation or particular needs of any particular person.  Before making an investment decision, you should consider, with or without the assistance of a professional advisor, whether the information provided in this material is appropriate in light of your particular investment needs, objectives and financial circumstances.  Transactions in securities give rise to substantial risk and are not suitable for all investors.