November 04, 2019 – KERR MARKET SUMMARY
Whether it’s the official transition into the colder months or the spooky holiday, October has been known in the financial world to raise anxiety levels. Though feared by some investors, the October Effect has been attributed to a psychological bias as opposed to a market rule. With no real evidence to authenticate it, this superstition was likely born in October 1929 when several bad market days preceded the Great Depression. Auspiciously, October 2019 did not fulfill this prophecy as the stock market hit all time highs at the tail end of the month. Progress on the U.S.-China trade negotiations and yet another interest rate cut at the end of the month were positive drivers for markets.
For the third time this year the U.S. central bank cut interest rates. Some investors have perceived this to be a move to support the U.S. economy ahead of the 2020 election. The trend of lower rates is causing investors to wonder if a fourth cut is to be expected in December. The Fed has reversed nearly all the rate increases completed in 2018, however they have signalled that they will pause to assess economic conditions before considering another rate reduction. The Fed’s dovish policy moves were well paired with generally positive economic reports to maintain investors’ spirits high. Recession fears in early October were appeased by non-farm payroll results that exceeded estimates, along with positive revisions to previously released results for August and September. The U.S. has created jobs at a pace above expectations, and more importantly the economy is performing well, adding fuel to the optimist fire. The October non-farm payroll signaled strength, which may validate the Fed’s stance that this may be the last cut in a while. The Fed’s strategy is inspired by a similar approach used in the mid 90’s, when the Fed equally cut rates on three occasions, successfully combatting an economic downturn and spurring the second largest expansion in history.
In the fixed income universe, the theme in 2019 has been the inverted yield curve and the impending recession it most often signals. In a healthy market, long-term bonds have a higher yield than short-term bonds as investors typically expect a higher return in exchange for committing their capital for a longer period. In mid-October, shorter-term Treasuries rallied, creating a reversal in the spread between the 3-month and 10-year rates. With the 25 bps drop in the Fed rate, the yield curve finally normalized and resumed its natural upward slope. This signaled that some investor uncertainty about the strength of the underlying economy has been lifted. The Canadian bond market ended the month at -0.2%, long-term bonds finished at -0.7%, short-term bonds at 0.2%.
The equity markets were fueled by increased investor confidence of a continued expansionary phase. The U.S. and China seem to be getting closer to reaching a trade deal. The geopolitical relationship is far from perfect and is riddled with strategic moves like the U.S. blacklisting several Chinese tech companies, and China retaliating with cutting NBA broadcasts. Experts remain cautious about the trade deal as it seems that key items like intellectual property theft have not yet been resolved. On a global scale, companies are navigating geopolitical forces like Brexit and slowing economic growth well. Global equities are withstanding such pressures and ended the month positively, with a majority of S&P 500 companies reporting financial results ahead of analyst expectations. Canadian and U.S. (S&P 500) stock markets closed October at -0.9% and 1.4% (CAD), respectively. Developed (MSCI EAFE) and emerging (MSCI EM) markets each returned 2.8% and 3.5%.
Accommodative monetary policy has certainly contributed to shoring up stock markets. While rate cuts give the markets a jolt, there are pockets of uncertainty ranging from trade tensions, to the ongoing impeachment process in Washington. Will these events jeopardize corporations from achieving investors growth expectations? While the short-term ebbs and flows are difficult to predict, we remain cautiously optimistic and continue to favor equities relative to fixed income and cash. We are keeping a watchful eye on indicators that would warrant that we begin shifting our strategic asset class targets.
Sources: Capital Economics, National Bank