October 2019 In Review

The S&P 500 Index eclipsed the July 2019 all-time highs with a solid 2.2% gain in October. Stocks followed the pattern in recent decades of above-average October performance while also living up to the month’s reputation as one of the more volatile on the calendar. The month got off to a rough start, falling more than 3% over the first two trading sessions on weak manufacturing data and ongoing trade concerns before climbing back on trade progress and signs of stabilizing global growth over the last three weeks of the month. The growth-heavy Nasdaq handily outpaced the S&P 500 with a 3.7% gain for the month, while the Dow Jones Industrials lagged with a mere 0.5% advance. The S&P 500 has produced gains in eight of ten months this year, bringing the year-to-date total return to 23% including dividends.

Optimism that United States and Chinese negotiators would soon finalize a trade agreement—referred to as phase  one—was a primary driver of the October advance. It’s no coincidence that the latest leg of the rally began October 9, right before negotiations began in Washington, D.C. Reports that the deal would include more than Chinese agriculture purchases and removal of U.S. tariff threats boosted investor sentiment. Reports late in the month indicated the agreement would include more rollbacks of tariffs than had been anticipated, increased access to Chinese markets for U.S. companies, a currency pact, looser restrictions on China’s telecom giant Huawei, and some intellectual property protections.

Anticipation of an eventual rate cut from the Fed, which the central bank delivered October 30, also helped support stocks during the month in October. Stocks historically have responded well to mid-cycle adjustments, which is how we would characterize the current rate-cutting campaign. Another delay in the United Kingdom (U.K.) exit from the European Union (Brexit), better-than-feared earnings results, better-than-expected third quarter GDP growth, and improving economic signals from bond markets further buoyed investor sentiment.

The reversals of stock market leadership experienced in September were short-lived, as this year’s leaders reasserted themselves in October: Large caps beat small caps, based on the Russell 1000 and Russell 2000 Indexes, and growth beat value, based on the Russell style indexes. Strength in the large cap growth index was driven by technology, while energy weakness dragged on the large cap value index. Large caps and midcaps are still in a pitched battle for year-to-date leadership with returns just over 23%, ahead of the 17% advance for small caps. Growth has a 7 percentage point performance advantage over value year to date.

Cyclical sectors generally performed better than defensive sectors during October, with two exceptions. Energy is a cyclical sector and was the month’s worst performer amid flat oil prices, and healthcare is more defensive and was the month’s best performer. Healthcare got a lift from strong gains in the pharmaceutical and biotech industries. Economically sensitive sectors that fared well included technology, which was boosted by double-digit gains in Apple shares and semiconductor stocks on positive China trade news. Communication services and financials were also firmly positive, while defensive sectors that lagged included consumer staples, real estate, and utilities. Technology remained the best-performing sector year to date with a 36.5% return.

The September outperformance of international stocks relative to their U.S. counterparts continued in October, bucking a years-long trend. The developed international benchmark MSCI EAFE Index returned 3.6% for the month, more than one percentage point ahead of the S&P 500, and has returned a more-than-respectable 17.4% year to date.

Evidence of stabilization in economic growth in Europe and Japan, a weaker U.S. dollar, progress on trade—particularly falling odds of tariffs on auto imports—and another delay in Brexit helped propel international benchmark outperformance. Japan topped the list of country contributors, based on the MSCI country indexes, which was particularly impressive given the consumption tax increase that was implemented at the start of the month. British, French, and German markets were also strong performers.

Emerging markets equities also outperformed the S&P 500 return amid trade progress, the Fed rate cut, and a weaker dollar. The biggest country contributors to gains for the MSCI Emerging Markets Index included Taiwan, China, Brazil, and Korea, all countries sensitive to global trade and the U.S.-China trade conflict. Year to date, the MSCI Emerging Markets Index has returned 10.7%.

U.S. Treasury yields stalled in October as fixed income investors weighed progress in the U.S.-China trade deal with easier monetary policy worldwide.

The 10-year yield increased three basis points (0.03%) in October, taking a breather after its biggest monthly gain since September 2018. The 10-year yield climbed as high as 1.84% on October 28 before falling to a three-week low of 1.69% to close out the month.

The yield curve steepened in October as short-term yields declined. The spread between the 2-year and 10-year yields climbed 12 basis points (0.12%), its biggest monthly gain since November 2016. The spread between the 3-month and 10-year yields turned positive after spending six months in negative territory.

Nine of 11 fixed income asset classes we track rose in October, as shown in the Fixed Income Performance Table. Local-currency emerging-markets debt led with a 2.9% gain, while preferred shares lagged with a 0.3% loss. The Bloomberg Barclays U.S. Aggregate Index (Agg) rose 0.3%, its seventh gain in eight months. The Agg climbed 8.8% year to date through October 31, poised for its best year since 2002. 

The HFRX Event Driven Index led alternative investment subcategory gains with a return of 1.3%. The index was supported by strong performance from underlying special situation managers, as well as modest returns provided by merger-arbitrage strategies. Healthy merger deal flow within the information technology and healthcare sectors continued to provide a constructive investment environment and an adequate opportunity set for new investments. Year to date, the HFRX Event Driven Index has gained 5.6%, with a beta to the S&P 500 of less than 0.1%.

As measured by the HFRX Equity Hedge Index, long/short equity funds gained 0.5% during October, bringing year-to-date performance to 8.4%. Since the beginning of September, the industry has continued to reduce momentum-related exposure, while there has also been a marginal net reduction in the relative weights of growth as compared to value exposure. While growth still accounts for a significant portion of the net exposure, this shift remains an important industry characteristic to monitor. The HFRX Market Neutral Index has been a beneficiary of the shrinking gap between growth and value, as strategies within the space typically have a value bias. For the month, the index also gained 0.5% with a beta of 0.03, as compared to the approximately 0.2 beta present in the long/short industry.

The HFRX Systematic Diversified Index declined 2.9% as losses in currency and fixed income trading weighed on performance. Specifically, many programs entered the month with short positions in the British pound and Canadian dollar, both of which experienced a strong rally against the U.S. dollar. Fixed income losses were concentrated in German bund exposure, as a back-up in yields led to losses in the well-established long trends.

October was a solid month for liquid real assets with gains across all major categories we track, with the exception of master limited partnerships (MLP).

Master Limited Partnerships

The Alerian MLP Index lost more than 6% in October, lagging significantly behind the broad equities indexes and other liquid real asset categories we track. Weakness in energy and higher-yielding defensive stocks weighed on the group, while higher natural gas prices and stable, low interest rates provided minimal offset (oil prices rose marginally). An earnings miss by industry giant Enterprise Products Partners also detracted from the group’s performance. Year to date, the Alerian MLP Index has returned 4%.

REITs and Global Infrastructure

The MSCI U.S. REIT Index gained 1.4% during October, trailing the S&P 500 for the month after outperforming in September and during third quarter 2019. The domestic REIT index has outperformed domestic equities by about 5.5 percentage points year to date. 

The industrial sector continued its streak as the top-performing sector for the month, outpacing the broad real estate index by nearly four percentage points in October as demand for industrial warehouses and distribution facilities continued to exceed supply. The industrial sector has outperformed the broad U.S. REIT index by more than 20 percentage points year to date. The self-storage sector was the worst performing real estate subsector in October with a loss of 6.6%, while the lodging/resorts subsector also significantly underperformed. Subsector performance is based on the FTSE NAREIT ALL REITs subsector indexes.

The S&P Global Infrastructure Index marginally underperformed U.S. equities in October with its 1.5% return, well behind international real estate but slightly ahead of U.S. REITs.