October was a solid month for risk assets. All major equity markets, except for emerging markets, had strong positive returns. Fixed income returns were negative.
- The Dow Jones Index of 30 stocks was up 14.1%, one of its best months in years. The S&P 500 appreciated by 8.1% and the Nasdaq 100 index of technology-oriented companies increased by 4.0%.
- The earnings season just passed its mid-point and earnings appear to be holding up. As of October 28th, 52% of the companies in the S&P 500 have reported actual results. Of these companies, 71% have reported actual EPS above estimates and 68% of S&P 500 companies have reported actual revenues above estimates.
- Valuations appear reasonable IF earnings hold. The forward 12-month P/E ratio is 16.3, which is below the 5-year average (18.5) and below the 10-year average (17.1). If a recession is on the horizon then earnings could be expected to decline. Speaking of the US economy......
- The US economy does not appear to be in recession, contrary to most market pundits. The initial reading for Q3-2022 GDP came in at 2.6% (annualized) and the Atlanta Fed is currently projecting GDP additional growth of 2.9% in Q4.
- Job growth remains solid, wages continue to increase and retail sales remain stable. Total nonfarm payroll employment increased by 261,000 in October, and the unemployment rate rose to 3.7 percent. Over the past 12 months, average hourly earnings have increased by 4.7 percent. US consumer spending has slowed recently but is up 7.8% on a year-over-year basis.
- Some future inflationary pressures should subside. The prices paid by companies has declined now for seven straight months. Food prices have fallen for six consecutive months. Supply chain bottleneck issues have declined for five consecutive months.
- While some inflation pressures could persist. The potential negatives for inflation include energy prices, wages and rent increases. Energy prices (oil and natural gas) remain elevated compared to a year ago but are well off their highs from Q1-2022, due in large part to the Biden administration’s decision to tap into the strategic petroleum reserve. Wages are still increasing. Rental prices remain high and home affordability has lessened with the average 30-year fixed mortgage rate greater than 7%.
- The Fed will continue to raise rates to fight inflation. At the November 2nd Federal Reserve meeting, the committee raised interest rates by 0.75%, the fourth consecutive 0.75% rate hike. This rate hike brings year-to-date increases to 3.75%. In addition, chairman Jerome Powell reiterated the Fed's top priorities include price stability, reducing inflation, and keeping wage growth in check. He also told the market to expect additional interest rate increases at the December 14th meeting.
- International underperformance is due to strong US dollar. Year to date, the US dollar has increased 28% versus the Japanese Yen, 13% versus the Euro and 15% compared to the Chinese Yuan. A strong dollar represents headwinds for US based investors holding international equities compared to local holders. As of October 31st, the year-to-date return for MSCI ACWI ex-U.S. in USD terms is negative 23.1% compared to negative 12.3%, a difference of 10.8%.
- If not for China emerging market stocks were positive. In late October, the Chinese reelected Xi Jinping to a third term as general secretary of the Chinese Communist Party (CCP). This action might explain why Chinese equities had a terrible month, down 16.8%. However, if one excludes China from the emerging market indices, emerging market stocks ex China gained 3.7% for the month.
Fixed Income (Bonds)
- US Interest rates rose again in October. The 10-year yield rose to 4.1% and the 30-year yield increased to 4.2%. Mortgage rates hit levels not seen in more than a decade with the average, national 30-year fixed mortgage at 7.1%. This is a strong negative for housing affordability.
- Cash is no longer trash. The silver lining from increased rates is clients now earn 3% in money market funds, 4% on 3-month, 4.5% on 6-month, and 4.7% on 1-year Treasury bills. C Safe investments like money markets and Treasuries create competition for risky assets and pressure equity valuations. The result has been a compression in price/earnings (P/E) multiples from twenty-one on 12-31-21 to fifteen as 9-30-22.
- Equity markets remain volatile, experiencing moves greater than 1% on most days.
- Fixed income offers high-quality yield for the first time in a decade.
- The downward equity price adjustments in 2022 have been painful. However, this reset lower in valuations allows for future expected market returns. Equities now trade at or near fair value, and bonds have positive, safe yields for the first time in a decade.
- Maintaining financial discipline is critical during volatile times and sets up portfolios for solid returns once this bear market ends.