October rebound kicks off Q4
E*TRADE Capital Management
Almost halfway through fall, the US stock market appeared to be embracing the season, reversing a September sell-off with a strong rally in the first month of what is traditionally the strongest quarter of the year.
Investors seemed to brush off inflation (including soaring energy costs), a Chinese economic slowdown, and continued supply chain disruptions to focus instead on a US economy that is still enjoying robust productivity, and an earnings season that has, so far, outperformed many analyst’s expectations.
Despite concerns that Q3 earnings would show profit margins were being squeezed by inflation and supply chain issues, most companies have not only beaten their headline earnings and revenue numbers, they’ve enjoyed wider margins, too: Outside the financial sector, S&P companies have actually reported an increase in their net profit margins over Q2.1
Despite some early choppiness, October turned out to be the strongest month for US stocks since last November, and the S&P 500, Nasdaq Composite, and Dow Jones Industrial Average hit multiple record highs toward the end of the month. The tech-heavy Nasdaq Composite led US indexes with a 7.3% gain, followed closely by the S&P 500 at 7%. Small-cap stocks lagged the market, with the Russell 2000 gaining only 4.3%:
All S&P sectors were positive for October. Oil companies continued to reap the benefits of the continued rally in crude oil (which soared to a seven-year high near $85/barrel), but consumer discretionary stocks managed to edge out the energy sector, although the latter increased its market-leading year-to-date return to 58.1%:
As stock markets around the world rebounded last month, developed markets outperformed emerging markets, which faded toward the end of the month. MSCI EAFE index of developed markets rallied 2.5% while the MSCI Emerging Markets (EM) index gained just 1%:
Longer-term interest rates mostly continued to climb last month, and bond prices, which move inversely to yields, mostly continued to fall.
At one point, the benchmark 10-year T-note yield rose to its highest level (1.69%) since May, but it retreated sharply at the end of the month to close October at 1.55%, up slightly from 1.53% a month earlier. But the yield curve also flattened from last month as shorter-term yields rose (the two-year yield hit a 19-month high) while the 30-year yield fell—a possible signal of reduced confidence in longer-term economic growth:
The US stock market has, so far, exhibited some of the historical bullishness that the fourth quarter is known for—both in terms of the Q3 reporting season and stock returns themselves.2 Here are a few other themes to keep tabs on:
- Interest rates and inflation. Rising interest rates and inflation will likely remain front-burner issues for the next six months to a year. To date, though, the economy is still enjoying technology-driven productivity gains that have at least partially offset inflationary pressures. But last Thursday’s weaker-than-expected GDP reading also highlighted the challenge the Fed faces in terms of supporting sustained growth while keeping inflation in check.
- Potential volatility. Don’t be caught off guard by volatility triggered by news about issues like the debt ceiling (which has to be reapproved by early December) or the launch of the Fed’s tapering initiative. While there’s little reason to believe the debt ceiling won’t be raised again, and the Fed has signaled for months that it was preparing to dial back its economic stimulus, that doesn’t mean the markets won’t get jolted by the occasional headline.
- Don’t forget China: Aside from China as a geopolitical factor, the economic slowdown in the People’s Republic is real—and it represents a potential headwind for global growth, which has been supported by robust Chinese economic growth for decades. The question is whether what’s happening is simply part of a natural economic ebb and flow, or a more potentially disruptive effort by the government’s “common prosperity” drive, which essentially seeks to redistribute wealth.
Just as some investors may have been overly negative when stocks retreated in September, some may be inclined to downplay risks when the market rebounds the way it did in October. As always, the goal is to hold the middle ground by maintaining a diversified portfolio and a long-term perspective.
Thanks for reading, and we’ll talk to you again next month.
Managing Director, Investment Strategy, E*TRADE Capital Management, LLC
Mike Loewengart is the Managing Director of Investment Strategy for E*TRADE Capital Management, LLC. Mike is responsible for the asset allocation and investment vehicle selections used in E*TRADE’s advisory platforms. Prior to joining E*TRADE in 2007, Mike was the Director of Investment Management for a large multinational asset management company, where he oversaw corporate pension plan assets. Early in his career, Mike was a research analyst focusing on investment manager due diligence for the consulting divisions of several high-profile investment firms. Mike holds series 7, 24, and 66 designations, as well as the Chartered Alternative Investment Analyst (CAIA) designation. He is a graduate of Middlebury College with a degree in economics.
Senior Director, Investment Strategy, E*TRADE Capital Management, LLC
Andrew Cohen is the Senior Director of Investment Strategy for E*TRADE Capital Management, LLC. Prior to joining E*TRADE, Andrew was the Director of Investments and Operations for a large Registered Investment Adviser, where his responsibilities included investment manager research, asset allocation, and portfolio construction. Previously, he was a Senior Research Analyst and Team Leader for a leading wealth management platform. He is a CFA® charterholder and a member of both the New York Society of Security Analysts and CFA Institute. He is a graduate of Virginia Tech with a BS in finance.
1 Bloomberg. The Margin Squeeze Bears Are Worrying About Has Yet to Happen. 10/27/21.
2 From 1960–2020, the S&P 500’s median October–December return (4.92%) was bigger than the median return of any other three-month period.