Both equity and bond markets began Q422 with lower prices and saw significant a significant turnaround as the month progressed. Treasury yields reached a cycle high before finding support while the stock market rallied sharply.
- The Dow Jones Industrial Average surged last month (+14.07%), notching its best October performance since 1976. The Nasdaq lagged with mixed earnings (+3.94%), and the SPX returned 8.10% keeping the “value versus growth” trade firmly in place for 2022.
- Energy sectors led the way as company earnings crushed analyst expectations (+24.84%). Industrials (+13.86%) and financials (+11.80%) had standout total returns.
- Lagging sectors included Consumer Discretionary (+0.20%) and Communication Services (-0.09%).
Interest rates continued to drift higher in October as both short and long-duration bonds saw higher yields. The U.S. 10 Year Treasury benchmark peaked on October 21st at 4.34% before ending the month at 4.05%. U.S. 2-Year Treasury Note yields continued to grind higher, closing just below 4.50% in October. The yield curve inversion has been powerful within the last three months, as 3 Month Treasury Bills have risen 174 basis points, 2 Year Treasury Notes have risen 160 basis points and 10 Years have risen 140 basis points.
- Investment grade corporate bonds, while still delivering negative total return last month, outperformed Treasuries by approximately 40 basis points
- Municipal bonds fared even better with some short bonds moving higher in price despite higher risk-free rates.
- High-yield corporate debt was a bright spot for fixed income as total returns topped 2% following equity risk.
The debate continued over the appropriateness of the FOMC’s continued aggressive pace of rate increases. Many investors believe policy is now restrictive and the Fed will have to begin to slow the pace of tightening going forward. The November 2nd decision to raise 75-basis points had already been priced in but going forward, expectations are for 75 basis point increases to be pared back. All eyes will be focused on any FOMC suggestions that future rate hikes will be less aggressive.
Expectations for the path of interest rates remains a positive catalyst while economic and company data was more mixed. Markets certainly had some twists and turns to begin Q4. As mentioned, talk of a “lighter” FOMC possibly due to global issues, drove stocks and bonds higher early in October. Markets seem to have taken into consideration the heightened possibility of an extraneous event, or something “breaking” that would create a run to safety and liquidity.
- A “liquidity” issue with Credit Suisse drove US bond yields lower and spooked investors of possible contagion risk to global markets.
- The Ukraine/Russia war continues to rage on, and discussions around tactical nuclear arms continue to elevate the “tail risk”.
Jobs data on Friday, October 7th, reasserted a strong labor market as non-farm payrolls rose 263k in September and the unemployment rate dipped to 3.5%.
Data points and continued robust CPI and PPI inflation figures were enough to reverse any early-month euphoria in both equity and fixed income markets.
Not all data was strong in October, housing continues to grind to a halt, as mortgage rates touched 7% last month. Manufacturing also showed some signs of weakness in economic releases. While Q3 GDP was released slightly stronger than expected at 2.6% growth (quarter-over-quarter), the third quarter GDP price index fell from 9% to 4.1%.
Core PCE also fell to 4.5% from 4.7%, suggesting inflation has already peaked.
The UK added to market uncertainty. Prime Minister Liz Truss enacted a tax plan for the UK that led to the instability of the pound. Nervous Gilt markets occurred as long duration insurance buying programs stepped down from supporting their bond market. The Bank of England stepped in to support markets with an open-ended bond buying program (essentially easing while they are tightening). The temporary stress to the UK bond and currency markets led to a reversal of the tax plan, and the removal of Liz Truss from office, who has become the shortest-serving Prime Minister in the history of the UK, just 44 days.
Other central banks were busy making policy shifts. The ECB raised their main financing rate by 75 basis points and mentioned recession risks and inflation levels would allow them to decide on rate increases from meeting to meeting. Interestingly, a day prior, the Bank of Canada raised rates by only 50 basis points (not the anticipated 75 bps), citing the worries about the impact of higher borrowing costs. This gave markets the notion of a more generalized central bank pivot, and both equity and bond prices moved higher.
Last month’s earnings reports kept equity markets quite volatile but ultimately lifted risk assets in general. Large energy players, like Chevron and Exxon, announced earnings showing large amounts of free cash flow. Exxon reported the highest profit in its 152-year history. The tech sector saw big wins and big misses. Chipmakers continued to remain a headwind, and the forward guidance for most of the sector seemed downbeat with warnings of slower sales, and a reduction of employees.
As November is upon us, mid-term election season may give markets some information to digest. Currently, probabilities suggest a divided congress which is historically beneficial to risk assets. The FOMC could easily overshadow the election cycle given the ongoing inflation fight.