October Recap: Gains Washed Away In A Sea Of Volatility

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Includes: DDM, DIA, DOG, DXD, EEH, EPS, EQL, FEX, FWDD, HUSV, IVV, IWL, IWM, JHML, JKD, OTPIX, PSQ, QID, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RWM, RYARX, RYRSX, SCAP, SCHX, SDOW, SDS, SFLA, SH, SMLL, SPDN, SPLX, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TNA, TQQQ, TWM, TZA, UDOW, UDPIX, UPRO, URTY, UWM, VFINX, VOO, VTWO, VV
by: Michael Loewengart

Summary

Equity headwinds, including tariffs, rising interest rates, and political uncertainty, created a downdraft of volatility in October.

International equities didn’t fare much better in October, although Latin American stocks experienced a remarkable resurgence.

High-quality bonds provided much-needed ballast to diversified portfolios in October.

Trivia question: When did the largest one-day point loss in the history of the Dow Jones Industrial Average occur? Answer: Just this year on February 5. How about the second largest? Also this year. Third largest? Same answer. You get the point. In fact, through the third quarter alone, the Dow Industrials tumbled by more than 500 points five separate times. And, yet, the blue-chip index gained nearly 7% during that time - a healthy clip by most any measure.

So when the markets again stumbled in early October, it seemed easy to shrug off the decline. After all, economic growth rates are robust, unemployment is low, and occasional bouts of volatility didn’t stop the major indexes from climbing to all-time highs in September. Moreover, October is traditionally a scary month for investors. Just another frightful fortnight in the pumpkin patch, right?

Maybe not. This time around, sustained market volatility appears to be more than just the ghouls of October at work. From the market’s highs on September 20 through October 31, both the Dow Jones Industrial Average and the S&P 500 Index have retreated within range of a 10% correction.

Source: FactSet Research Systems, November 1, 2018

U.S. equities

Equity headwinds, including tariffs, rising interest rates, and political uncertainty, created a downdraft of volatility in October. Although tech stocks took it on the chin, information technology is still up more than 9% on the year, underscoring just how lofty valuations within the sector have become.

Financials were hit hard by a softening housing market, with building and construction ETFs performing especially poorly in October. Despite rising interest rates, which typically expand banking profit margins, financials are now among the worst-performing sectors year-to-date, eclipsed closely by materials. Conversely, consumer staples and utilities - both defensive sectors - gained modest ground in October.

Source: FactSet Research Systems, November 1, 2018

International equities

International equities didn’t fare much better in October, although Latin American stocks experienced a remarkable resurgence. Somewhat counterintuitively, markets appeared to react favorably to the election of a hard-line authoritarian, Jair Bolsonaro, as Brazil’s new president - perhaps because investors welcome any change in Brazil after years of economic stagnation.

In Europe and Asia, stocks sold off on many of the same concerns that afflicted US markets, including rising trade barriers and concerns about global economic growth. In China, economic sentiment continued to weaken due in no small part to the trade war being waged by the Trump administration.

Source: FactSet Research Systems, November 1, 2018

Fixed income

High-quality bonds provided much-needed ballast to diversified portfolios in October. With investors seeking a haven from equity market volatility, demand for U.S. Treasuries spiked and yield spreads widened. The yield on the benchmark 10-year Treasury note, which had climbed as high as 3.23% on October 8, fell to 3.15% by month-end. Municipal bonds, which were strong performers earlier in the year, saw returns decline for the second consecutive month.

Source: FactSet Research Systems, November 1, 2018

Looking ahead

As we head into the holiday season, investors have a lot to digest, and although antacids may seem to be in order, we believe there are a number of themes that could make current market turbulence easier to stomach.

• Midterm elections: Midterm elections have a long history of fueling market volatility, but they have historically preceded market rallies. Once the political dust settles on November 7, months of uncertainty that have rattled investors will finally be history, regardless of the political makeup of Congress.

• Fixed income exposure: Over the past month, bonds have again proven their value as a portfolio stabilizer. If equity market volatility continues to escalate, fixed income allocations could help cushion the blow by making portfolios less vulnerable to unpredictable market swings.

• Corporate earnings: Third-quarter earnings season is in full gear, and already we have seen a number of high-profile earnings misses and downward guidance revisions. To what extent market participants focus on earnings disappointments could make the difference between a market setback and a full-scale correction.

While investors are still grappling with many unknowns, it’s hard to argue against a backdrop of 3.7% unemployment, GDP growth rates in the 3% to 4% range, and measured inflation. There is likely still steam left in the economy, which is why the Federal Reserve remains in tightening mode. For investors, staying diversified and adhering to long-term financial goals remains an effective way to weather any volatility we could see over the duration of 2018.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.