The month of October has a reputation for scaring investors. The one-day crashes of 1929 and 1987 happened in October. And who could forget the 17% drop in stock prices that occurred during the depths of the financial crisis back in 2008. While the drop last month was mild by comparison—with the S&P 500 index falling 7% for the month—it still represented a significant fall. The drop materialized seemingly out of nowhere since most domestic stock indices had just hit all-time highs the previous month. At one point in October, many stock indices were posting negative returns for the year before a rebound in the last two days pulled the more popular indices like the Dow and S&P 500 back above the zero line.
As with most shocks to the system, sectors that had been the strongest (technology and consumer discretionary) fell the most. However, defensive sectors (consumer staples, utilities, and real estate) held up nicely on both a relative and absolute basis for the month. This is a somewhat positive sign and is even more intriguing given that these categories are typically the most interest rate sensitive in the market. Since the beginning of 2017, growth areas, including the aforementioned technology and discretionary, along with healthcare, have been the clear leaders of this market. That may soon be changing, but the weight of the evidence has not yet given us a definitive signal.
Stocks of smaller companies were hit hard as investors sought shelter in larger, blue-chip companies that may be better suited to handle more turbulent economic conditions. We had expected that financial stocks (particularly regional banks) would have performed relatively well in this rising rate environment since they make more money if interest rates are higher. This leaves the question that maybe investors are not completely sold on the idea there is going to be an impactful, long-term change regarding U.S. interest rates.
Overseas, European and emerging market equities continue to vastly underperform U.S. equities. Nerves over the trade wars have hurt Chinese markets much more than our own here in the U.S. However, equities in Brazil have been a lone bright spot following the election of a new president. Because Brazil is generally viewed as a “canary in the coal mine” for other emerging market economies, this could be a positive development in turning around the negative sentiment we have seen through most of this year.
While headlines about trade wars and the Federal Reserve make it confusing to perceive the direction of the market over the next 6 to 12 months, we will remain grounded in our choice to follow price. As noted in previous market updates, we are watching the price range shown below. Until the S&P 500 index moves out of this trading range, we will continue to retain a significant level of cash in our portfolios.
As this article is being written, the mid-term elections have been decided. The result was in line with expectations, with the Democrats now holding a slim majority in the House of Representatives and the Republicans retaining control of the Senate. While this outcome will no doubt put a crimp in the Trump agenda—including talk of another tax cut—from an historical standpoint, the market generally prefers a split of leadership between the president and Congress since one party can act as a check on the other.
Because we continue to hold some equities in our strategies, our accounts benefited from the strong rebound over the past week; however, stocks remain vulnerable to revisiting the low levels hit in late October. As a result, we want to see the major averages re-establish momentum above their long-term trend lines before bringing the cash levels down significantly. Even though Halloween is behind us, there could still be a few market scares before the end of the year.
We want to remind you that most mutual funds will be paying their year-end distributions between now and December 31. As part of this process, you may see the value of these funds (and your portfolio value) drop to reflect those payments. This is normal, even though your account may appear to have lost value. Once the distributions are reinvested into your accounts (usually the next day), your account value will increase accordingly, back to normal.
Finally, we want to thank you for your loyalty and friendship with us over the years. It is an honor and a pleasure to work with you and to act as your financial guide through the seasons of life.
If you have family members or friends who are concerned about their investments during turbulent times like these and would like to explore an alternative to the “buy and hope” approach of most firms, please have them call or email us. We would love to talk with them.