Markets Unphased by October Frights
MONTHLY MARKET COMMENTARY |
- Equity markets rebounded in October to new all-time highs, while U.S. Treasury yields trended higher, which led to modest declines across most fixed income asset classes.
- U.S. and global central banks took initial steps toward tightening monetary policy. (For historical perspective, markets produced positive returns when the Federal Reserve last shrank its balance sheet from 2015 through 2019.)
The market volatility that emerged late in the third quarter quickly abated in October. After U.S. large-cap stocks declined in September (the first monthly decline in seven months and the first drawdown of more than 5% for the year), the S&P 500 advanced 7.0% in October, supported by resilient corporate fundamentals. Overcoming supply chain bottlenecks and inflationary pressures, 84% of S&P 500 companies have beaten earnings expectations1 thus far in the reporting period—a near-record high—with profits advancing 32% year over year2. The rotation into value stocks that took place in late September was short-lived, with the Russell 1000 Growth Index (8.7%) outgaining the Russell 1000 Value Index (5.1%). Small-cap stocks (Russell 2000 Index) returned 4.3% but have now trailed the return of large-cap stocks in seven of the last eight months. International markets (MSCI ACWI ex-U.S. Index) returned 2.4%, as investors weighed diminishing concerns surrounding the potential default of Chinese property developer Evergrande, along with the impact of energy shortages, particularly in China and the United Kingdom.
Returns were modestly lower across most fixed income asset classes for the month. Persistent inflationary pressures stemming from supply chain constraints and expectations for less accommodative monetary policy pressured the U.S. 10-year Treasury yield to continue the ascent that began from its intra-year low of 1.19% on August 4th, finishing the month at 1.55%3. Meanwhile, the yield of two-year Treasuries has doubled since mid-September to 0.48%4, reflecting a rising probability of an initial rate hike in 2022. U.S. investment-grade bonds (Bloomberg U.S. Aggregate Bond Index) were nearly unchanged as the spreads of the highest-rated segments of corporate credit fell to levels below their pre-crisis lows5, offsetting the impact of higher Treasury yields. Five-year inflation expectations rose to their highest level since 20066, leading Treasury Inflation-Protected Securities (Bloomberg US Treasury US TIPS TR) to advance 1.1%.
A Policy Transition
A pivot away from emergency levels of fiscal and monetary stimulus has begun in recent months7. In September, Federal Reserve (Fed) Chairman Jerome Powell indicated the central bank is likely to begin tapering its asset purchase program in November, and now nine of 18 FOMC members expect a rate hike will come in 2022.
Policymakers outside the U.S. have been more aggressive in their response to rising inflation. Central banks in South Korea, Australia, Brazil, Russia, Mexico and Norway8 recently moved official rates up from historical lows. Meanwhile, the Bank of England indicated it could raise rates by year end, and the European Central Bank will likely announce the retirement of its Pandemic Emergency Purchase Program next March.
Of note, equity markets displayed resilience throughout the last cycle of monetary policy tightening. The Fed reduced its balance sheet from a peak of $4.5 trillion in October 2014 to $3.8 trillion in August 20199, while raising the federal funds target rate from a range of 0.00% to 0.25% in late 2015 to a range of 2.25% to 2.50% through early 201910. Investors who remained invested through an initial spike in volatility in the early stages of policy normalization were rewarded with an average calendar year return for the S&P 500 of 12.5% from 2015 through 201911.
Markets continue to weigh solid economic activity and corporate earnings against the potential impacts of inflationary pressures and a transition to less accommodative monetary and fiscal policies. Domestic equities have ascended with historically low volatility to all-time highs after S&P 500 earnings expanded 94.2% year over year in the second quarter12. Yet, sentiment based on a somewhat evolving macro-economic outlook has caused abrupt swings in leadership within broader indices.
With the recovery of S&P 500 earnings to above pre-crisis levels and valuations at elevated absolute levels, we expect equity markets will likely trend more in line with earnings growth in coming years with persistent shifts in style leadership possible as investors grapple with the transition to more normal levels of economic activity and monetary policy. To this end, we recommend investors maintain a portfolio anchored by reasonable long-term return expectations, with diversification across assets that may benefit from a variety of macro-economic conditions.
- “Expecting the Exceptional,” Northern Trust, October 22, 2021
- “Strong Earnings Propel Market Higher,” MFS, October 22, 2021
- Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/DGS10
- Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/DGS2
- Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/AAA10Y
- Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/T5YIE
- “Contribution of Fiscal Policy to Real GDP Growth,” Brookings Institute – Hutchins Center of Fiscal Impact, https://www.brookings.edu/interactives/hutchins-center-fiscal-impact-measure/
- “Central Policy Rates,” BIS, https://www.bis.org/statistics/cbpol.htm
- Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/WALCL
- Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/DGS2
- “U.S. Equity Market Attributes,” S&P, September 2021, https://www.spglobal.com/spdji/en/commentary/article/us-equities-market-attributes/
This document contains general information, may be based on authorities that are subject to change, and is not a substitute for professional advice or services. This document does not constitute audit, tax, consulting, business, financial, investment, insurance, legal or other professional advice, and you should consult a qualified professional advisor before taking any action based on the information herein. Information has been obtained from a variety of sources believed to be reliable though not independently verified. RSM US LLP, its affiliates and related entities are not responsible for any loss resulting from or relating to reliance on this document by any person. Internal Revenue Service rules require us to inform you that this communication may be deemed a solicitation to provide tax services. This communication is being sent to individuals who have subscribed to receive it or who we believe would have an interest in the topics discussed. Past performance does not indicate future performance. The sole purpose of this document is to inform, and it is not intended to be an offer or solicitation to purchase or sell any security, or investment or service. Investments mentioned in this document may not be suitable for investors. Before making any investment, each investor should carefully consider the risks associated with the investment and make a determination based on the investor’s own particular circumstances, that the investment is consistent with the investor’s investment objectives.
Tax and accounting services are provided by RSM US LLP, a registered CPA firm. Investment advisory, aggregated reporting, financial planning, retirement plan advisory and other wealth management services are provided by RSM US Wealth Management LLC, an investment advisor registered with the U.S. Securities and Exchange Commission (SEC) and wholly owned subsidiary of RSM US LLP.
RSM US LLP is a limited liability partnership and the U.S. member firm of RSM International, a global network of independent audit, tax and consulting firms. The member firms of RSM International collaborate to provide services to global clients, but are separate and distinct legal entities that cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other party. Visit rsmus.com/about us for more information regarding RSM US LLP and RSM International.
RSM, the RSM logo and the power of being understood are registered trademarks of RSM International Association.
© 2021 RSM US LLP. All Rights Reserved.
Equity markets largely shrugged off headline risks — the S&P 500 Index posted its seventh straight monthly gain.
July was, on balance, a good month for investors. Many broad market indexes across equity and fixed income posted positive returns.
Global capital markets posted modest gains during May with value stocks outpacing their growth counterparts and international markets.