Market Commentary: October 2019

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Investment Strategy Team
November 13, 2019
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Looking Back: October Highlights

The first week of October got off to a rough start, both domestically and globally. On October 8, the S&P 500 Index and MSCI All Country World Index (ACWI) were down 2.8% and 2.4%, respectively. However, as seasonality kicked in alongside an alleviation (though not elimination) of economic and trade concerns, the markets shifted into high gear, rising 5.0% and 4.4%, respectively, to all-time highs by the end of the month.

[caption id="attachment_3974" align="alignleft" width="650"]

S&P 500 Performance: October 2019

Source: FactSet[/caption]

Consolidations typically give the market time to digest news and move equities from weaker hands to stronger hands (i.e., from investors less likely to hold for the long run to investors who are more likely to do so). Two months ago, we suggested the longer the consolidation, the stronger the eventual breakout. Refreshing the same exhibit, we now see we may be in the early stages of a strong rally.

[caption id="attachment_3987" align="alignleft" width="649"]

S&P 500 Performance (March 2009 – October 2019)

Source: FactSet[/caption]

International equity markets exhibited a second consecutive month of strength, reinforcing the idea that a declining slowdown in global PMIs may be signaling a bottom in global weakness. The combination of a trade truce and further easing by the Federal Reserve have helped reduce some upward pressure on the U.S. dollar, further buoying international markets. It will still take some time to determine whether this is the start of a new trend or merely a time out from U.S. equity market dominance.

[caption id="attachment_3972" align="alignleft" width="650"]

International Developed (MSCI EAFE) vs. United States (Russell 1000)

Source: FactSet[/caption]

[caption id="attachment_3970" align="alignleft" width="651"]

Emerging Markets (MSCI EM) vs. United States (Russell 1000)

Source: FactSet[/caption]

As expected, the Federal Reserve lowered the federal funds rate by 25 basis points at the end of October. In parallel with rising equities, interest rates ticked up, a further indication of easing concerns. Importantly, the yield curve has almost entirely reversed its inversion, a move that began in September. And while one could not attend a cocktail party a few months ago without discussion of the yield curve inversion, we hear nary a peep from the financial press regarding the “un-inversion!”

[caption id="attachment_3973" align="alignleft" width="650"]

Yield Curve at the end of August, September, and October

Source: FactSet[/caption]

The reversal of the inversion is likely a sign of two important items:

  1. The bond market is relatively satisfied with Fed action to date. Thus, it would come as no surprise if the Fed has completed its “mid-cycle adjustment.”
  2. Increased confidence that recession fears may be overblown. This is not to suggest investors should be wholly unconcerned about some of the economic data, however.

Other October Occurrences

  • U.S. jobs and wage data continue to be strong. Slowing economic growth should not be confused with a recession, and we believe the following figures drive home that point.
  • U.S. Bureau of Labor Statistics (BLS) reports revealed 128,000 job gains during October, far exceeding expectations. Furthermore, it contemplated the negative impacts of 20,000 census workers coming off federal payrolls and 42,000 striking auto workers; thus, the true sustainable job creation was even higher than the reported figure.
  • Metrics for August and September were revised upward by 51,000 and 45,000, respectively.
  • Wage growth of 3.0% remains above inflation, giving consumers more real disposable personal income. If the U.S. consumer is to continue to drive the economy, this is welcome news.
  • There were several movements on the trade front during the month. First and foremost, the Trump administration announced it completed Phase 1 of a trade deal with China. U.S. farmers stand to be the main beneficiaries of the deal, which most notably specifies the purchase of U.S. agricultural products. Since both sides have felt economic pain, we are not surprised to see a partial truce. Also, the U.S. and Japan finalized a limited trade agreement which also accrues benefits to U.S. farmers in exchange for reduced tariffs on many Japanese industrial goods, with the hope of a more comprehensive agreement with Japan in 2020.
  • The International Monetary Fund (IMF) slashed its 2019 global growth forecast from 3.3% to 3.0%, citing trade barriers and increased geopolitical tensions. The IMF has frequently been late to the party with its downgrade forecasts, and in light of the aforementioned beginning of trade thawing and continued strong employment figures in the U.S., we would not be surprised if this is the case yet again.

What We're Watching

  • Any potential developments indicating additional trade solutions are imminent.
  • Possible implications if oil prices move higher than seasonal patterns have historically shown.
  • The recent rise in interest rates and potential impacts on interest rate-sensitive equities. Concurrently, we will monitor if recent trends in international equities turn into a sustainably higher move against U.S. equities.
  • The current rally has been very broad-based, as we see strength across a swath of domestic sectors and global regions. Sectors such as financials and industrials (whose stocks were left for dead not long ago) have reached multi-year highs. Contrast this with the highs in early and late 2018, which were very much dependent on the FANG stocks and a few global regions. Whether stocks reach sustainable levels both nationally and globally is dependent on the rallies' ability to maintain strong breadth across industries and geographic locales.

What’s in Store for Capital Markets?

  • The S&P 500 broke out to new all-time highs in October, and momentum has continued into early November. Seasonally, November/December tends to be the strongest period of the year, which could augur more gains heading into 2020. Of course, there are no guarantees, as we saw last December.
  • Continued weak sentiment should buoy stock prices. For example, only 27% of money managers in Barron’s latest poll call themselves bullish, the lowest percentage of bulls in more than 20 years. Similarly, 31% of managers consider themselves bearish, also more than a two-decade high. Numbers such as these frequently serve as a contrarian indicator since equities tend to climb a “wall of worry.”
  • Bond yields should continue their modest climb on the back of Federal Reserve policy and decreased economic concerns. We do not anticipate rates to approach last November’s highs (when the 10-year Treasury note peaked at 3.25%), but ongoing rotation into stocks could lead the 10-year Treasury to challenge resistance at the 2% level.
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