A Month At A Glance
- Following a nearly 13% loss in the previous two months, US stocks surged 8.1% higher in October
- Higher rates led to a loss of 1.3%for US core bonds
- Value stocks outperformed, nearly doubling the return of growth stocks
- Emerging-markets equities underperformed, largely due to continued weakness in Chinese markets
Hopes that the Federal Reserve might soon ease off their restrictive stance helped propel equities higher in October. The Dow Jones Industrial Average (which is tilted more towards value stocks) jumped 14.1%—its best month since January 1976. The more tech/growth-oriented NASDAQ Composite was also positive, but with a smaller 3.9% gain. The S&P 500 gained 8.1% in October, narrowing its year-to-date loss to 17.7%. (The market’s hope that a Fed pivot might be in the works was largely dashed as of this writing. More on the November FOMC meeting below.)
Developed international and emerging-markets equities underperformed US stocks in October. The MSCI EAFE developed international markets index gained a solid 5.4% in the month. However, emerging-markets stocks returns were dragged lower by Chinese equities and notched a loss of 3.1% in October. The MSCI China Index had a notable decline of 16.8% in October. Much of that fall happened on October 24th, the first trading day following the end of the 20th National Congress of the Chinese Communist Party (CCP). It was widely expected that Xi Jinping would be reappointed as the CCP General Secretary for a third time. However, the Politburo Standing Committee was stacked with six other Xi loyalists. This cements his rule over the country and was not viewed positively by the markets.
Markets were expecting a fourth straight increase of 75 basis points in the Fed Funds rate at the November 2nd FOMC meeting, and the Fed delivered on this—bringing their target level to 3.75%-4.0%. The often-cited 10-year minus 2-year Treasury yield spread (typically a harbinger of a recession) has been inverted since the summer. However, an even more accurate historical recession predictor is the 10-year minus 3-month spread. This spread had remained positive this year, but on October 31st, the 3-month Treasury yielded 4.22%, exceeding the 10-year Treasury rate of 4.10%. As shown in the chart below, these two yields have reliably inverted prior to past recessions, with a brief exception in 1998.
Higher rates in the US resulted in a negative return of 1.3% for the Bloomberg US Aggregate Bond index. Corporate spreads narrowed during the month, which helped corporates outperform the core bond index. The US Corporate index fell 1.1%, while the US High Yield index fared well with a gain of 2.6%.
The two notable events over the last few weeks were: (1) the aforementioned 20th National Congress of the Chinese Communist Party and (2) Fed Chair Powell’s November 2nd FOMC statement and press conference.
Xi Jinping’s victory at the Party Congress was not a surprise. What was somewhat of a surprise was that only members of his faction make up the new Politburo Standing Committee (PSC). Historically, the PSC had representatives from other factions within the Chinese Communist Party. However, Xi packed the PSC solely with loyalists and allies. China is a one-party state; however, Xi’s consolidation of power puts it further down the path of one-man rule. With potentially nobody to challenge Xi, his ideology and policies will become even more core to the country’s economic, social, and geopolitical direction.
The PSC will be tasked with righting China’s sputtering economy—as the country is dealing with issues in its real estate sector, the impact of their zero-COVID policy, and growing tensions with the US (particularly over the semi-conductor industry). All of these issues have weighed heavily on investor sentiment and Chinese equity markets over the past year. The MSCI China index has fallen more than 60% since early 2021. Valuations are depressed (forward P/E ratio around 8x) and earnings are at decade lows. Should news out of China become incrementally positive, a meaningful rebound in their markets could take place.
Turning to the Federal Reserve, the fourth interest rate hike of 75 basis points in early November was a foregone conclusion for much of October. However, the market was hopeful that the Fed might turn less restrictive in future meetings. Markets initially thought it found language hinting at a pivot or pause in the FOMC statement where it said: “In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” Equity markets initially moved higher following the statement’s release.
However, during his press conference, Chair Powell struck a more hawkish tone and made it clear that bringing down inflation was still the Fed’s primary concern. His tone grew hawkish when a reporter told him equity and bond markets were reacting positively to the statement and his comments. He responded saying, “We have some ground to cover before we get to that level of interest rates that we think is sufficiently restrictive.” And he noted that if the committee were doing their Summary of Economic Projections today, their target level of rates would be higher than it was last September. Chair Powell went on to say that “It’s premature to discuss pausing and it’s not something that we’re thinking about [and] that’s really not a conversation to be had now.” He reaffirmed his commitment to bringing down inflation and the need to err on the side of doing too much. Equity markets turned lower following his comments and closed the day down 2.5%.
We did not make any asset allocation changes in October. As discussed in our Third Quarter Commentary, we did lower our emerging market equity exposure in portfolios during the quarter. We continue to believe downside risks for equities have increased, while at the same time prospective returns from core bonds have increased following the spike higher in rates.
Certain material in this work is proprietary to and copyrighted by Litman Gregory Analytics and is used by Argent Financial Group with permission. Reproduction or distribution of this material is prohibited, and all rights are reserved. Argent Financial Group is the parent company of Argent Trust, Heritage Trust and AmeriTrust.