Monthly Commentary

October 2018 Commentary

After almost nine years of steady stock market advances the market drop this October naturally came as something of a shock, even if we know, intellectually, that market declines of this nature are inevitable. For the month, the S&P 500® Index fell -6.8% with a late-month rally softening the monthly low on October 29th when the Index was had dropped more than -9% since September 30. At this point year-to-date returns were fractional, but the bounce over the final two days brought the 2018 S&P 500 return back to 3.0%. As we’ve been forewarning, just as the market gains over the past few years have been concentrated in favored sectors and stocks, so were this month’s losses. The gap in sector performance this past month was a substantial 13.7%, with the top-performing Utilities Sector up 2.4% and Consumer Discretionary down -11.3%. In a reversal of long-standing trends, value stocks outpaced growth, as the mega-cap tech stocks led the market decline. Thanks to our disciplined approach to valuation and company fundamentals and diversification into quality bonds, your portfolio showed considerable resistance to the market correction.

More important than this past month’s performance is an attempt to understand the underlying dynamics of the market selloff. This downturn can be attributed to a combination of elevated valuations, rising interest rates and a growing recognition that this year’s tariffs are having a direct impact on many companies’ input costs and margins. At the same time, there is little to promote the notion that we are entering a full-blown recession. While there has been considerable anxiety over future corporate earnings, recent reporting has been positive, much of the reason the market rallied at month end.

Among all the leading indicators, the main troublesome note is the softening of the housing market, often a harbinger of broader economic difficulties. However, we also need to take into account the effect of rising mortgage rates and the dampening of demand via the new tax code, which diminishes the tax benefits of home ownership, particularly in high-end real estate. Given these real estate exceptions and given the continued strength of corporate earnings and the robustness of consumer spending, it is far too early to call for a significant decline in the domestic economy.

That is not to suggest that we are past the worst and sailing into smooth water. The global economy strikes us as considerably less stable than our own, particularly in light of potential trade wars, and we are always subject to the shock effects of geopolitical disruptions. Little of this month’s market volatility seemed to be precipitated by election jitters and the most likely outcomes, including the predicted shift in House leadership, have not troubled investors. It seems likely that much of the bump in U.S. GDP growth in the first half of the year will boil down to temporary causes, including inventory buildup ahead of the tariffs. We expect more modest, positive GDP results going forward.

Another lesson to be gained from this past month is the importance of stock valuation and the defensive value of investments based on fundamentals rather than expectations or hope. The relative outperformance of these stocks during this downtrend matches our experience and expectations. It’s also part of our long-held discipline that we’ve found to be a major aid in helping investors hold their course. By investing in companies which can continue to generate positive results through more challenging times, we all can feel comfortable with maintaining the appropriate asset allocation targets which we believe will reward investors over time.

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  • Nothing contained herein is intended to be a recommendation to buy or sell any security. This material is for informational purposes only and should not be taken as investment advice of any kind whatsoever (whether impartial or otherwise). November 2, 2018 - All Rights Reserved.

    “Madison” and/or “Madison Investments” is the unifying tradename of Madison Investment Holdings, Inc., Madison Asset Management, LLC, and Madison Investment Advisors, LLC, which also includes the Madison Scottsdale office. Madison Funds are distributed by MFD Distributor, LLC. Madison is registered as an investment adviser with the U.S. Securities and Exchange Commission. MFD Distributor, LLC is registered with the U.S. Securities and Exchange Commission as a broker-dealer, and is a member firm of the Financial Industry Regulatory Authority.

    Although the information in this report has been obtained from sources that the firm believes to be reliable, we do not guarantee its accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitute the firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.
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    In addition to the ongoing market risk applicable to portfolio securities, bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally, the longer a bond’s maturity, the more sensitive it is to this risk.

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