Last month lived up to October’s traditional reputation as a difficult one for global stock markets. As political pundits discussed an “October surprise” in the context of the U.S. presidential election, investors were busily reacting to a series of developments that ultimately depressed returns. Stocks were pushed down in part by better-than-expected economic data, which investors viewed as raising the odds the Federal Reserve will increase interest rates in December. Falling oil prices also weighed on stocks as negative sentiment regarding OPEC’s failure to commit to production cuts outweighed the supportive impact of declines in U.S. crude inventories. Lastly, FBI Director James Comey’s surprising announcement on October 27 of the discovery of an additional cache of emails potentially tied to presidential candidate Hillary Clinton’s use of a private email server during her term as secretary of state injected unwelcome uncertainty. By market close that day, U.S. stocks had suffered a nearly 1% decline. For the month, larger-cap U.S. stocks (Vanguard 500 Index) were down 1.8%; dividend-paying sectors such as telecom services and REITs were among the biggest decliners.
European stocks (Vanguard FTSE Europe ETF) also declined during the month, ending 3.5% lower than where they started. Investor unease over the extent of future European Central Bank stimulus was one factor driving European stocks lower. Concern over a “hard Brexit,” with the United Kingdom losing trading access to the E.U. single market, was another. British Prime Minister Theresa May’s tough rhetoric on reducing immigration and reining in the Bank of England’s accommodative stance on interest rates ratcheted up these fears. The British pound sterling suffered major declines during October, tumbling to a low of $1.22 versus the dollar by the end of the month. That eclipsed its initial post-Brexit low of $1.33. More broadly, the dollar appreciated 3% against developed market currencies during the month, benefiting our hedged European stocks position (Deutsche X-trackers MSCI Europe Hedged Equity ETF). Emerging-market stocks (Vanguard FTSE Emerging Markets ETF) presented a relative bright spot, turning in essentially flat performance (up 0.3%).
On the macroeconomic front, additional signs of strengthening were evident. Initial U.S. GDP growth figures released for the third quarter of 2016 were a lofty (relative to the recent post-recession period) 2.9%, a marked increase from the second quarter’s 1.4% pace. On the microeconomic front, company earnings have so far largely met or exceeded previously lowered guidance. Notably, the financials sector performed well, leading others in positive earnings surprises. With the bulk of U.S. companies having reported, the potential for large-scale negative surprises appears to be receding.
Bonds followed the same trend as stocks, with the core bond index (Vanguard Total Bond Market Index) down 0.8% for the month. The yield on the U.S. 10-year Treasury jumped by nearly 30 basis points, ending October at 1.84%, up from 1.56% at the start of the month. Firming economic data and the prospect of rising inflation, both key supports for interest rate rises, prompted the selloff. While the Fed did not take any action at its meeting this week, the recent data suggest an even more solid case for the Fed to raise rates by 25 basis points in December. Labor market figures due out later this week could lend further support to an improving economic picture.
—Litman Gregory Research Team (11/1/16)