In October, primary US markets faced continued challenges, largely due to the sobering realization of another conflict in the Middle East. This led to heightened volatility in both equity and bond markets, with investors demonstrating a heightened sensitivity to inflation indicators, economic data and statements from the FOMC. The steep rise in rates along the longer end of the yield curve rattled stock prices, especially during an unpredictable earnings season. Despite the downturn in markets, the start of the fourth quarter brough some encouraging data points including a robust consumer sector, a robust job market, and signs of the Central Bank adopting a more cautious “wait and see” approach to monetary policy tightening.
During October, all sectors of the S&P, except for utilities (+1.23%), experienced declines. Notably, the energy sector recorded the most significant drop (-6.08%), even amid uncertainties related to the conflict in Israel and significant mergers in the energy industry. Consumer discretionary stocks followed (-4.51%). An interesting observation from earning reports was the strength in banking stocks. Despite positive surprises, many remain cautious about the future of consumer-related sectors.
Broad financial markets continued to erode total return following a strong first half of 2023. The S&P500 fell 2.10% for the month, the Nasdaq fell by 2.76% and the Dow Jones Industrial Average dropped by 1.26%, briefly entering negative territory for the year. The S&P’s total return remained in positive territory at 10.68% for 2023, while the Nasdaq continues to lead with a return of +23.61%.
The bond market has become a pivotal factor for macro investors and asset allocators. Many markets seemed to be in a wait-and-see mode, monitoring whether yields would continue to rise significantly or stabilize as longer-term support levels. Notably, in the volatile month of October, the US 10-year note surpassed a 5% yield level on the 23rd, marking the first time since July 2007. Equally significant for the market was the ongoing “re-steepening” of the yield curve. Shorter-term bonds, like the 2-Year Treasury note, saw only a 4-basis point increase during the month. In contract, the 10-Year and longer-term bonds experienced a rise of over 30 basis points. This move resulted in the 2-10 year spread having only a 14-basis point inversion, a considerable improvement from the 100 basis point inversion just a few months ago. These upward movements in the long-term yield curve reflect cycle highs and are driven by a robust job market and consumer sector, a watchful eye on the FOMC maintaining the “higher for longer argument”, and persistent wage inflation as evident in the PCE data. The increase in supply in treasury auctions, combined with less-than-stellar results in the treasury markets continue to make investors exercise caution from a technical standpoint.
Despite these factors, it’s challenging to overlook the absolute level of rates and how long it has been since we’ve seen the yield curve and investment grade securities at these levels. The potential for capital disintermediation, where investors shift between equity risk and bond risk, could be come a significant theme in the upcoming months. For instance, the yield on the S&P 500 is currently lower than that of a 10-Year Treasury yield. At some point, investors may favor the lower risk associated with the investment-grade bond market over the risks associated with equity investments.
Cash served as the best-performing fixed income asset last month, with certain segments of the short-duration market also delivering positive returns.
Credit sectors saw a modest spread widening, causing corporate bonds to underperform government bonds. Higher credit quality outperformed lower credit quality investment-grade debt. High-yield bonds fell but continued to outperform the investment-grade sector. Emerging market bonds fell over 1.3% during the period. Primary issuance in the corporate debt market reached approximately $81 billion, falling just short of expectations for October. Corporations are expected to seize the opportunity for financing before the holiday season begins. In early October, the average yield to worst for US investment-grade debt stood at 6.13%, a level not seen since 2009, and large US Banks traded new issue 10-year bonds at 6.5%.
Municipal bonds, while still down for the month, outperformed all other segments in the investment-grade bone category. The higher absolute yields enticed investors to buy and hold these bonds. The relative value of tax-free bonds has become more appealing when compared to corresponding Treasury bonds in certain durations. Bonds with maturities of 10-15 years, offering nearly 4% yields, have become attractive to conservative investors. In high-tax states such as California, New York, and New Jersey, “taxable equivalent yields’ on in-state issues have reached levels of 9-10%. Municipal yields rose by approximately 20 basis points across the yield curve last month, with investors anticipating a reduction in supply in the coming months, which could provide a tailwind heading into year-end.
The beginning of October was marked by a significant focus on geopolitical events, particularly the outbreak of was in Israel over Columbus Day weekend. The bond market experienced its most substantial rally since March, with US 10-year notes dropping from 4.80% to 4.55% over just two trading sessions following the attack. Simultaneously, the stock market climbed until mid-month as earnings season got underway. However, as the fourth quarter progressed, investors began to grapple with the challenging and unpredictable geopolitical landscape, featuring two wars and other global issues. Consequently, earnings data, statements from Federal Reserve speakers, and economic data once again became central factors for macro investors, who south to assess market direction based on interest rates and the likelihood of soft-landing scenarios for the US economy.
The month of October did not start out too focused on inflation or economic data, as war broke out in Israel around Columbus weekend. The bond market saw its largest rally since March with US 10-year notes falling from 4.80% to 4.55% over 2 trading sessions after the attack, and the stock market rose until mid-month into earnings season. But as the 4th quarter is under way, investors have realized the geopolitical backdrop with 2 wars, and other global issues are too difficult to gauge. Earnings data, Fed speakers, and data points drove macro investors back to markets based on rates, and probabilities of soft-landing scenarios in the US economy.
The September jobs data proved to be unexpectedly strong, surprising skeptics. Non-farm payrolls exceeded expectations, adding 366,000 jobs for the month, well above the anticipated 170,000. Revisions to prior months also showed higher job gains. This development not only broke the trend of slower reports in the third quarter, but the average hourly earnings data also remained steady. The confluence of robust employment figures and lower inflation pose the question of a “Goldilocks” scenario or more work to be done by the Federal Reserve?
Inflation data showed some fluctuations, with the Produce Price Index (PPI) registering a slight increase last month, while the Consumer Price Index (CPI) met expectations. The US Core Personal Consumption Expenditures Price Index, which is the Fed’s preferred gauge of underlying inflation, recorded the sharpest price increase in four months, driven by elevated spending on goods and services, including cars, prescription drugs, and travel. While salaries and wages grew, disposable income declined for the third consecutive month, resulting in the lowest savings rate since January. Investors anticipate that this situation will keep the Federal Reserve cautious throughout the fourth quarter.
As the FOMC convened on November 1st, the market appeared to discount the possibility of immediate Fed action. Expectations lingered for a potential rate increase in December, but many believed the committee would adopt a more patient “wait and see” approach. FOMC members expressed a wide range of opinions in the previous month, with dovish comments suggesting that current interest rates were appropriate, boosting bond prices, while comments indicating the need for further action to combat inflation weighed on both equity and bond markets. Chairman Powell maintained a balanced tone in October, emphasizing the need for more data before making decisions. Expectations point toward another pause with a hawkish tone, suggesting that a tightening bias remains.