October was a frightening month for risky assets. Comments from the Federal Reserve suggesting higher U.S. interest rates, continued trade tensions between the U.S. and China, and expense and profit margin pressures for big companies conspired to push bond yields up and stock prices down.
Month-over-month returns were in the red for most asset classes. U.S. small company stocks fared the worst, falling nearly 11% during the month. International and emerging markets stocks weren’t far behind, losing 8-9% of their value, and U.S. large company stocks dropped by nearly 7%.
Bonds, which often can act as a counterweight when stock prices fall, were no refuge in October. While shorter-maturity Treasuries generally held their value, riskier bonds declined. Corporate bonds and securitized debt fell by about 0.5% and high yield bonds dropped by more than 1.5%. Two segments of the market did post positive returns: floating rate bonds, up 0.1% and gold, up 2.1%.
Fed. During a recent interview, Federal Reserve Chairman Jerome Powell said, “We may go past neutral, but we’re a long way from neutral at this point, probably.” The market saw this as confirmation that monetary policy will become progressively more restrictive. Treasury bond yields jumped by 0.14 percentage points on October 3 (an outsized move), and stocks began their month-long slide the next day.
Earnings. A theme from the start of the 3th quarter corporate reporting season has been continued strong earnings growth tempered by rising cost pressures and some profit margin compression. Investors sensed the approach of peak earnings for this business cycle and slower growth for 2019, which weighed on stock prices.
U.S. Economy. U.S. GDP growth came in at 3.5% for the third quarter, exceeded expectations. October’s payroll report also surprised to the upside, and employment gains were widespread, including large increases for manufacturing and construction. Unemployment held at 3.7% (a 49-year low), and wages rose a more-than-anticipated 3.1%. One emerging weak spot in the U.S. economy appears to be residential housing, where recent statistics including sales, new housing starts and building permits indicate that this market may have peaked early this year.
International Developments. In contrast to the U.S., the most recent reading of Eurozone GDP (for 2Q) increased by 1.5%, slightly below expectations. Also, for most of October, the market fretted about escalating trade tensions between the U.S. and China. However, the tone seemed to shift a bit more in a positive direction in early November. Markets responded favorably to President Trump’s announcement of a ‘very good call’ with Chinese President Xi, and a newly scheduled meeting at the end of November between the two leaders.
Closing Thoughts. The October equity drawdown was a sharp reaction to a change in expectations for interest rates and corporate profits. At this point, we seem to be quite a distance from conditions that will result in a bear market for equities. We favor staying invested in a broadly diversified portfolio.
Rob Kania is Principal and Co-Founder of Laurentide Advisory