As ghosts and other assorted characters arrived on my doorstep Halloween night, I couldn’t help but think back to the issues that have spooked investors for much of this year. Somehow, just as those scary costumes arrived, those fears were fading, if perhaps momentarily.
Stocks surge, buoyed by preliminary U.S.-China trade deal.
Fed rates cuts start to lift economy.
Political risk rises as presidential race and impeachment inquiry heat up.
In mid-October, the U.S. and China reached a détente in their prolonged trade war, one of the biggest risks to the global economy. President Trump unveiled a “substantial, phase one deal” in which the U.S. agreed to not increase tariffs on Chinese goods as planned, provided China purchases larger quantities of American agricultural products. However, the details of the agreement may take weeks to finalize.
The interim accord buoyed investor sentiment—as did signs that the Federal Reserve, like a watchful parent on Halloween night, has doled out enough goodies this year (in the form of several modest rate cuts) to begin to sweeten the economic picture.
All this renewed optimism surrounding the trade war and economy pushed stocks broadly higher last month. The bond market eked out a very modest gain, but it enjoyed solid gains for the year-to-date and 12-month periods.
Stocks—which began to rebound in September after a lackluster summer—saw strong momentum in October. The S&P 500 index gained slightly more than 2%, bringing year-to-date returns to about 23%, according to data from Bloomberg.
As in September, some higher-risk areas of the market outperformed in the last month, although large-capitalization stocks remained in the lead on a year-to-date basis. Emerging market stocks, for instance, returned more than 4% in October, suggesting that developing economies are starting to benefit from looser monetary policy worldwide.
Investors were not only encouraged last month by the breakthrough in trade negotiations and certain economic indicators, but also relieved that third-quarter corporate earnings weren’t quite as grim as many analysts feared they would be.
As of November 1, companies in the S&P 500 had reported third-quarter sales gains of 3.3% per share, according to Bloomberg. Meanwhile, earnings declined by 2.7% per share, although 75% of companies beat analysts’ expectations—which exceeded the five-year average of 72%, according to Factset. Excluding the volatile energy sector, S&P 500 companies fared even better: Sales per share climbed by nearly 4%, according to Bloomberg, and earnings per share were slightly negative (down around a half a percentage point), according to Factset.
Interestingly, a similar dynamic played out in non-U.S. developed markets, which boosted international equities last month. For example, European equities (as tabulated by Bloomberg) posted third-quarter sales growth of 0.45%, while earnings decreased by 1%.
The strength of last month’s rally is also worth noting. In late October and early November, the New York Stock Exchange advance-decline line (a measure of the number of advancing stocks versus the number of declining stocks) reached new highs, according to data from Bloomberg. The advance-decline line helps us gauge the breadth of a rally or decline, which can be skewed by fluctuations in the share prices of a few large companies.
Health Care sprang back to life in October, thanks in part to better-than-expected earnings among some of the sector’s biggest names. In recent months, healthcare companies have found themselves in the crosshairs of the presidential race because of issues like high drug prices. Uncertainty over the regulatory outlook has weighed on the sector, which, like Energy, had the lowest returns of all S&P 500 sectors on a year-to-date basis through October.
Certain cyclical sectors—including Technology, Communication Services, and Financials—also shined last month. Technology was not only among the best-performing sectors in October, but it led the way on a year-to-date basis, returning more than 36%. Communication Services contains several tech-oriented companies, including Facebook Inc., Google parent Alphabet Inc., and Netflix Inc.
Some defensive sectors—which tend to hold up relatively well during turbulent economic times—lost ground last month, including Utilities and Consumer Staples. Still, Utilities and Real Estate, which benefit from declining interest rates, were the two best-performing sectors for the trailing twelve months through October.
After stumbling in September, the bond market saw a positive return last month, but not by much. The market gained less than half a percentage point, and the return for longer-dated Treasurys was slightly negative.
Nonetheless, the market has posted solid returns over the last year thanks to strong demand for safe-haven assets and the search for positive yield in a world awash in negative-yielding debt. The Bloomberg/Barclays U.S. Fixed-Income Aggregate, the general measure of the U.S. fixed-income market, gained nearly 9% and more than 11%, respectively, for the year-to-date and trailing 12-month periods. Longer-dated Treasurys led the way, returning nearly 14% and about 20%, respectively.
Interestingly, corporate bonds have also shined over the past year, outperforming the broader bond market for the year-to-date and trailing 12-month periods. We believe that with the Fed cutting rates several times this year, many investors have grown less concerned about the near-term economic outlook and are more inclined to take on risk, which boosts demand for assets such as corporate debt.
The Economy and The Federal Reserve
Over the course of this year, economic growth has decelerated amid heightened uncertainty surrounding the trade stand-off between the world’s largest economies.
But we’re beginning to see signs that the Fed’s dovish pivot in January is filtering through to the overall economy. Last month, the central bank, which hiked rates four times last year, cut its benchmark rate for the third time this year in an effort to inoculate the economy against the effects of the trade war and slowing global growth.
Looser monetary policy appears to be making a difference in some key sectors that have slowed earlier this year. For instance:
The Institute for Supply Management’s closely watched monthly manufacturing index improved slightly in October after several months of deceleration—although it showed that the sector was still contracting.
Pending home sales ticked up 1.5% in September, marking two consecutive months of increases tied in part to historically low mortgage rates.
The U.S. economy still faces headwinds—including the potential for more setbacks in U.S.-China trade negotiations and uncertainty surrounding the fine print of the latest accord. The slowdown in China—which in the third quarter saw its economic growth fall to the lowest rate in decades on a year-over-year basis—poses a threat not just to the U.S. economy, but to global growth.
In the U.S., political risk also looms large as the presidential race and impeachment inquiry simultaneously shift into high gear. The Democratic candidates for president have begun to unveil their specific proposals on key issues, eliminating some uncertainty. Yet, if history is any guide, a political changing of the guard—in whatever form that may take—should have only a marginal effect on the economic cycle over the long term. In more ways than one, the soundness of our democratic institutions is ultimately what matters most.
Reflecting on what makes America great (no matter your political persuasion) seems appropriate as early fall passes, and we prepare to count our blessings over the Thanksgiving holiday. It’s also a good time to remember that the smart investor re-evaluates risk—and, if necessary, adjusts his or her portfolio accordingly—when the market is at or near a high, portfolios are healthy, and minds are clearer, not when investors are spooked by headlines and behaving rashly.
As always, a thoughtful discussion with your advisor when market returns are positive is the best setting to evaluate and adjust your long-term plans.
Live richly and invest well,
Kara Murphy, CFA®
Chief Investment Officer
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S&P 500 Index: A broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. It is a capitalization-weighted, unmanaged index that is calculated on a total return basis with dividends reinvested. The S&P 500 represents about 75% of the NYSE market capitalization.
Russell 2000 Index: This index measures the performance of approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks; the index serves as a benchmark for small-cap U.S. stocks.
MSCI Europe, Australasia, and Far East (EAFE) Index: This index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada.
MSCI Emerging Markets Index: This index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. As of June 2009, the MSCI Emerging Markets Index consisted of the following 22 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
Bloomberg Barclays U.S. Aggregate Bond Index: This is a market capitalization weighted bond index of investment-grade, USD-denominated fixed-income securities.
U.S. High Yield Corporate: The Bloomberg Barclays U.S. Corporate High Yield Bond Index measures the USD-denominated, high-yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.
U.S. Investment Grade Corporate: The Bloomberg Barclays U.S. Corporate Bond Index measures the investment-grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial, utility, and financial issuers.
Bloomberg Barclays Municipal Bond Index: The Bloomberg Barclays U.S. Municipal Index covers the USD-denominated, long-term, tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds.
S&P 500 GICS Sectors Level-1: In 1999, MSCI and S&P Global developed the Global Industry Classification Standard (GICS) to offer an efficient investment tool to capture the breadth, depth, and evolution of industry sectors. GICS is a four-tiered, hierarchical industry classification system. It consists of 11 sectors, 24 industry groups, 68 industries, and 157 sub-industries. Companies are classified quantitatively and qualitatively. Each company is assigned a single GICS classification at the sub-industry level according to its principal business activity. MSCI and S&P Global use revenues as a key factor in determining a firm’s principal business activity. Earnings and market perception, however, are also recognized as important and relevant information for classification purposes and are considered during the annual review process.
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