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Stock markets tumble on rising rates, fears of disappointing earnings

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Thursday, October 11, 2018 – Page B1

The dramatic downturn in stocks on Wednesday, the worst day on Wall Street in eight months, suggested that the new North American trade agreement and the parade of upbeat U.S. economic reports have taken a back seat to what investors fear is coming next: Rising borrowing costs and squeezed profit margins.

Global stocks plummeted just days after U.S. indexes celebrated fresh record highs amid simmering concerns about rising bond yields, increased trade tensions between China and the United States and speculation that corporate financial results will soon disappoint. U.S.

technology stocks and Canadian energy names were among equities hardest hit.

The S&P 500 fell 94.66 points, or 3.3 per cent, to 2,785.68, touching a three-month low. The Dow Jones Industrial Average fell 831.83 points or 3.2 per cent, to 25,598.74.

The turbulence occurred well beyond U.S. markets though. British stocks fell 1.3 per cent and German stocks fell 2.2 per cent.

In Canada, the S&P/TSX Composite Index fell 336.65 points or 2.1 per cent, to 15,517.40.

The latest dip continued a losing streak for Canadian stocks that began last week soon after political leaders tentatively agreed to the United States-Mexico-Canada Agreement (USMCA), removing a key concern over North American trade.

The market mayhem also follows a winning streak for U.S. economic readings, including Friday's 50-year low for the unemployment rate and the best-ever monthly gauge of service-sector activity. As well, analysts expect companies in the S&P 500 will report third-quarter profit growth of more than 20 per cent, year-over-year.

But this sunny backdrop could bring tighter monetary policy from the U.S. Federal Reserve, which has already raised its key interest rate three times this year in an effort to cool the economy and reduce inflationary pressures. Higher rates are raising questions about the impact of steeper borrowing costs and how long the nineyear economic expansion can continue.

The bond market is sending troubling signals that are rippling through the automotive and housing markets. The yield on the 10-year U.S. Treasury bond, which spiked to seven-year highs last week, continued to move higher this week, peaking at 3.25 per cent.

"We thought we would get a pause here at 3, 3.1 per cent on the 10-year bond and we kind of blew through that," Paul Nolte, portfolio manager at Kingsview Asset Management in Chicago, told Reuters.

Bond yields, which move in the opposite direction to prices, retreated from their highs later in the day as investors began to rush to the relative safety of fixed income assets.

But the fact that bonds are driving stock-market sentiment is raising comparisons to the stock market downturn earlier this year, when the S&P 500 fell 10 per cent between January and April.

Canadian lumber stocks, which are exposed to U.S. home-building activity, were down sharply. West Fraser Timber Co. Ltd.

fell 3.7 per cent, to a one-year low. The stock has fallen 32 per cent since June.

Canadian Pacific Railway Ltd. fell 6.6 per cent, wiping out last week's rally that had coincided with an upbeat financial forecast. Canadian National Railway Co.

fell 5.5 per cent.

In the United States, technology stocks were among the biggest drags on major U.S. indexes. Among the so-called FAANG stocks, Facebook Inc. fell 4.1 per cent, Inc. fell 6.2 per cent, Apple Inc.

fell 4.6 per cent, Netflix Inc. fell 8.4 per cent and Google parent Alphabet Inc. fell 5.1 per cent.

"The big concern isn't really what thirdquarter earnings numbers are, but really what the outlook for the fourth quarter and first quarters are," Oliver Pursche, chief market strategist at Bruderman Asset Management in New York, told Reuters.

West Texas intermediate (WTI) crude oil, a U.S. benchmark, fell $2.14 to US$72.82 a barrel. And the price of Western Canadian select oil relative to WTI widened to a discount of US$47 a barrel - its cheapest level in at least 10 years - weighing on Canadian energy stocks. Suncor Energy Inc. fell 3.2 per cent and Encana Corp. fell 6.3 per cent.

Stéfane Marion, chief economist and strategist at National Bank Financial, believes that part of the problem with today's stock market is that global companies have been lowering their profit expectations for the next 12 months.

This trend began with emerging markets, where companies are struggling with rising U.S. interest rates and local currency depreciation - but it is now spreading to U.S. companies because of challenges to their profits margins.

"We continue to see margin expansion as difficult to achieve in this mature phase of the economic cycle under conditions of rising interest rates, higher oil prices, a strong U.S. dollar, deceleration in emerging markets and very tight labour market conditions that will raise production costs," Mr. Marion said in a note.

"Whether global equities rebound in the coming weeks will depend on the outlook for corporate profits and the extent of the rise in long-term interest rates," he added.

Investors also may need to see indications of a thaw in the relationship between the United States and China. On Wednesday, though, tensions appeared to be rising.

Media reports suggested that the White House will would look more closely at Chinese investments in U.S. companies in an attempt to protect U.S. technology on national security grounds. And U.S. Treasury Secretary Steven Mnuchin told the Financial Times that trade talks between the United States and China must include a discussion on currency devaluations by China, in light of the tumbling yuan this year.

"As we look at trade issues, there is no question that we want to make sure China is not doing competitive devaluations," Mr. Mnuchin told the Times.

Associated Graphic

On Wall Street, technology stocks were among the biggest drags on the major indexes. BRENDAN McDERMID/REUTERS

Traders work the New York Stock Exchange floor on Wednesday. Analysts forecast companies in the S&P 500 will report third-quarter profit growth of more than 20 per cent year-over-year. BRYAN R. SMITH/AFP/GETTY IMAGES

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