The fourth quarter began with a sharp stock market sell-off and spike in volatility. By mid-October, U.S. stocks had fallen nearly 10% (in intraday trading) from their previous high before rebounding and closing the month in positive territory and at a record high. Overall, large-cap stocks rose 2.4% for October, bringing their year-to-date gain to 10.8%. Smaller-company stocks, which have lagged for much of the year, also rallied in the last weeks of the month, gaining 6.6% for October and tipping into positive territory for the year (up 2% through October 31).
The month’s dramatic fall and subsequent rise suggest a market significantly influenced by the ongoing flow of news. In the first part of the month, stocks declined as investors seemed to grow more concerned over a range of big-picture worries including the global economic outlook (with Europe, Japan, and China all showing signs of faltering growth), eurozone deflation risk, and uncertainty surrounding monetary policy (i.e., next steps for global central bankers). What was striking is that none of these concerns were wholly new; moreover, the month’s subsequent rally occurred largely against the same set of headwinds, albeit with some new developments that may or may not have longer-term impact. Among the news that helped shift the U.S. market’s tenor in the second half of the month was better-than-expected third quarter earnings for U.S. corporations and the first data release of U.S. GDP growth for the third quarter, coming in at 3.5%. Overall, the U.S. economy has averaged around 2% growth since the recovery started in mid-2009. While this is well below the average economic recovery, it appears increasingly attractive as other major economies continue to struggle.
Central bankers also made news in the month’s second half. In the United States, the Federal Reserve announced the conclusion of its QE bond-buying program as expected but also adjusted its post-meeting written statement to acknowledge further positive progress in economic growth and employment. Nonetheless, the Fed maintained its statement that it expects interest rates to stay low for a considerable period of time following the conclusion of its bond buying. At the very end of the month, the Bank of Japan surprised economists and investors by announcing additional stimulus, increasing its asset purchases to 80 trillion yen (about $730 billion). Separately, Japan’s major pension fund announced it would invest more in stocks. In response, Japanese stocks rallied and the yen fell relative to the dollar. Expectations are high that the European Central Bank will eventually undertake outright QE (asset purchases) in the face of very low inflation and subpar growth. The bottom line for many investors is that even as the Fed begins to scale back its support, monetary stimulus remains a global support for stocks.
The divergence in economic outlooks (reflected in central bank policies) has contributed to strong returns for the U.S. dollar relative to other currencies. As was true in the third quarter, this factor was a performance drag on international stock returns for U.S.-dollar-based investors. Looking at international stocks in aggregate, October was negative. More specifically, Europe suffered losses in both local-currency and U.S.-dollar terms, while Japan rose in local-currency terms, thanks to its end-of-month rally, but was negative in U.S.-dollar terms. Emerging markets were positive, however, as the index’s largest components—China, India, and Brazil—gained. The stronger dollar is among potential clouds to the U.S. economic forecast, as this could at some point crimp exports. It’s also the case that slower growth for major trading partners could be another headwind: China’s growth slowed during October, with third quarter GDP growth coming in at 7.3% (below the government’s official 7.5% target); Japan’s economic growth stalled in the second quarter following implementation of a sales-tax hike earlier this spring; and Europe’s economic growth is barely positive.
The bond market’s October performance was the mirror image of stocks’. After rallying at the beginning of the month—sending the 10-year Treasury yield briefly below 2% as prices rose—bonds fell later in the month and the 10-year yield ended at 2.335%. All totaled, the core bond market proxy we follow rose 0.9% and high-yield bonds rose 1.1%.
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