Markets Recover from Summer Swoon

• Equity markets surged in October, even as the U.S. Federal Reserve opened the door wider to a possible December rate hike.
• U.S. large-cap stocks rallied over 8% during the month, outperforming small caps.
• Outside the U.S., developed and emerging markets showed impressive gains, each up more than 7%.
• U.S. fixed income markets ticked slightly higher in October, though news from the Fed prompted a wave of selling at month’s end.

Overview

In October, both U.S. and international equities surged, giving investors much-needed relief after the market’s sharp correction of summer and early fall. Actions by central banks in China and Europe encouraged market optimism and contributed to further gains in the U.S. dollar. Meanwhile, the U.S. Federal Reserve surprised investors by suggesting that a December rate hike was firmly on the table, triggering a sell-off in certain corners of the fixed income market.

U.S. equities roar back to life: The summer of ’15 was a long one for investors, as the S&P 500 posted its weakest quarterly performance in four years. It’s only fitting, then, that October set a four-year record of its own, though this time in the opposite direction: U.S. large caps jumped more than in any month since October 2011. Why the dramatic move? It could be that the market was simply oversold and correcting to the upside. Earnings season also kicked in during the month, and while announcements were mixed, strong numbers from several large technology companies helped drive markets higher. Materials and energy stocks were also strong performers, even as oil prices remained low.

December rate increase back in play: In its official statement following October’s meeting, the Fed seemed more hawkish than many investors had expected. It was generally upbeat about the U.S. economy and seemed to downplay concerns related to international markets. The statement even specifically—and somewhat unusually—alluded to the possibility of a rate hike at the Fed’s next meeting. If the Fed does raise rates in December, it’s likely to move by 25 basis points (one quarter of one percent). While seemingly small, this kind of increase could have a substantial effect on investor sentiment, as it could imply that the economy is strong enough to withstand tighter policy.

GDP slows, but consumers undeterred: In the first estimate from the U.S. government, economic growth in the U.S. slowed in the third quarter. Gross domestic product (GDP) dropped to 1.5% from the red-hot 3.9% it had posted in Q2. The quarter’s softness was due primarily to a drawdown of inventories by U.S. businesses. Spending by the all-important U.S. consumer, however, grew by a healthy 3.2%, as gas prices stayed low and the job market continued to firm. The U.S. economy added 142,000 new jobs in September (the most recent month for which we have data), and the unemployment rate held steady at 5.1%, its lowest level since 2008.

Domestic Equities

U.S. stocks rallied sharply in October, nearly reversing the deep losses of the previous few months. The month’s star performers were U.S. large caps, which led not only domestic small caps, but also international equities.

The large-cap-oriented S&P 500 surged 8.44% in October, its biggest gain since late 2011. On a year-to-date basis, the index is again in positive territory, with a year-to-date gain of 2.70%.

Small caps also moved sharply higher for the month, though their gains were smaller than the other major equity indexes we track. The small-cap-oriented Russell 2000 Index powered ahead 5.63% in October, and is now down just 2.53% for the year.

Taking a closer look at the U.S. financial sectors—as defined here by the S&P 500 sector indexes—can reveal a lot about what’s going on beneath the surface. In October, all sectors finished in the plus column. Materials, energy, and information technology were the best performers for the month, while utilities, consumer staples, and financials were the weakest. Consumer discretionary stocks remain the best-performers year to date, followed by information technology and health care. As for the laggards, even this month’s rally couldn’t lift the energy sector from its position at the back of the pack, as oil producers continued to struggle on weak pricing.

Turning our focus to the equity styles, both growth and value stocks rallied in October, though the former outperformed the latter by a full percentage point. On a year-to-date basis, growth is significantly ahead, as investors continue to prefer positions with higher expected growth rates.

International Equities

International equities also surged in October. Their gains were powered by a number of important developments, including the sixth rate cut in a year from China’s Central Bank, as well as news that the European Central Bank was considering additional stimulus.

In general, developed and emerging markets advanced in tandem. Developed markets, however, ended the month slightly ahead.

The MSCI EAFE Index, a widely followed measure of developed market performance, gained 7.82% in October. Among the index’s component countries and regions, Japan moved sharply higher, while Europe performed roughly in line. On a year-to-date basis, the index is now back in positive territory, with a gain of 2.13%.

Also charging higher in October was the MSCI Emerging Markets Index, which rose 7.13% for the month. The index, however, started the month significantly in the red, and is still down 9.45% year to date.

Fixed Income

The U.S. fixed income market edged slightly ahead in October, as a more hawkish stance from the U.S. Fed rattled bond investors. The Barclays U.S. Aggregate Index gained just 0.02% for the month, and is now up 1.14% year to date.

Turning to the U.S. Treasury market, the yield on the benchmark 10-year note increased 10 basis points to end the month at 2.16%. (A basis point is one one-hundredth of a percent.) Year to date, the yield on the 10-year is now down one basis point. U.S. Treasury yields took their cue from the Fed and steepened all along the curve.

Among U.S. fixed income sectors, high-yield bonds (also known as “junk” bonds) were the strongest performers in October, as investors seemed more comfortable taking on higher-risk assets. Intermediate and long-term U.S. Treasuries, however, were the weakest. On a year-to-date basis, intermediate-term U.S. Treasuries have gained the most, while TIPS (Treasury Inflation-Protected Securities) have been held back by consistently restrained inflation projections. Long-term U.S. Treasuries have also lagged.

Summary

Investors who felt stressed about the market’s volatility over the summer may have been relieved in October as equities bounced back. But what about investors who grew nervous, and sold stocks or stock funds in August or September? Unless they bought back at just the right time (which is very difficult to do), they likely missed out on October’s impressive gains.

Whether or not the above applies to you, taking a look at your approach to the markets over the past few months can provide important insight into your tolerance for risk. For instance, if you felt compelled to sell when the market soured, you may have been positioned too aggressively. Risk tolerance is very personal and hard to define, but high-volatility markets can help bring it into sharper focus.

So what should you do? Of course, only you can say for sure, but we encourage you to use this experience as an instructive one. Take a look at how you felt when stocks were skittish. Be realistic about your temperament. Now that the market’s bounced back, it might be a good time to evaluate your holdings and see whether it makes sense to reset your portfolio to a risk level that feels more comfortable for you.

Long-term portfolios are built on the assumption that each of us will stay invested—and often invest more—through all the peaks and valleys along the way. With a diversified portfolio in line with your risk tolerance, you’ll have exposure to a wide variety of asset classes, including both domestic and international equities, as well as bonds. As a result, you may be able to weather short-term market downturns more effectively, and perhaps even benefit from them.

Thank you for reading.

Mike Loewengart
Vice President, Investment Strategy
E*TRADE Capital Management

Mike Loewengart is the Vice President of Investment Strategy for E*TRADE Capital Management, LLC. 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. Mike started his career as a research analyst and an investment manager due diligence analyst for the consulting divisions of several high-profile investment firms. He also graduated with a degree in economics from Middlebury College.

 

 
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Indexes used in this presentation are intended to provide a general measure of the market performance for a particular asset class or type. An Index is an unmanaged portfolio of predetermined securities and does not reflect any initial or ongoing expenses such as brokerage fees, commissions, principal mark-ups, management fees or taxes. The inclusion of any one of these items would reduce the performance shown. It is not possible to invest directly in an index.

Index definitions:

Dow Jones Industrial Average: Computed by summing the prices of the stocks of 30 companies and then dividing that total by an adjusted value—one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities.

Barclays Capital U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.

Dow UBS Commodity Index: The DJ-UBSCI is composed of futures contracts on physical commodities. Unlike equities, which typically entitle the holder to a continuing stake in a corporation, commodity futures contracts normally specify a certain date for the delivery of the underlying physical commodity. In order to avoid the delivery process and maintain a long futures position, nearby contracts must be sold and contracts that have not yet reached the delivery period must be purchased. This process is known as “rolling” a futures position. The DJ-UBSCI is composed of commodities traded on U.S. exchanges, with the exception of aluminum, nickel and zinc, which trade on the London Metal Exchange (LME).

MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following 21 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 23 emerging market country indexes: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.

S&P 500 Index is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the US stock market.

The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 8% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.

The Russell 3000 Growth Index measures the performance of the broad growth segment of the U.S. equity universe. It includes those Russell 3000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 3000 Growth Index is constructed to provide a comprehensive, unbiased, and stable barometer of the broad growth market. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics.

The Russell 3000 Value Index measures the performance of the broad value segment of the U.S. equity universe. It includes those Russell 3000 companies with lower price-to-book ratios and lower forecasted growth values. The Russell 3000 Value Index is constructed to provide a comprehensive, unbiased, and stable barometer of the broad value market. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect value characteristics.