Fund investors saw a lot of red ink on their statements in October from the stock market.
Bond funds got hit again as the 10-year Treasury yield topped 5% for the first time since 2007. Stock funds weren't spared, either. The S&P 500 hit correction territory on its way to its first three-month losing streak since the start of the pandemic in March 2020.
The bottom line: There was nowhere for investors to hide as financial conditions tightened as bond yields continued to move higher. October was another risk-off month for markets.
"Investors don't want volatility right now," said Russ Koesterich, manager of BlackRock's Global Allocation fund, commenting on investors' mindset in October. "And with 10-year U.S. government bonds around 5%, bonds are starting to provide some real competition for stocks. That's something we haven't seen in a long time."
Sizing Up A Rough October For The Stock Market
Last month, however, even investors with diversified portfolios lost ground.
The average diversified stock fund tumbled 3.71%, shrinking its year-to-date gain to 3.48%, according to Refinitiv Lipper data. And fixed-income funds, which typically provide ballast to a portfolio, offered little shelter. Vanguard's Total Bond Market ETF, which tracks the U.S. bond market, fell 1.52% amid a continuation of a broad bond market sell-off.
Investors with investments overseas suffered losses, too. The iShares Core MSCI EAFE ETF, which tracks large, midcap, and small stocks in developed countries outside the U.S. and Canada, slid 3.09%.
Heading into the final two months of the year, however, there are some potential green shoots investors are eyeing.
For one thing, third quarter GDP came in at a strong 4.9%, which suggests the economy remains resilient and corporate profit growth can reaccelerate. The weaker-than-expected October job growth number could allow the Federal Reserve, which held its key interest rate steady at 5.25% to 5.5% at its early-November meeting, to stay on hold. And November starts what historically has been the best six-month seasonal stretch for stocks.
Finding Bullishness In The Stock Market
Those bullish drivers could help markets stabilize and rally into year-end.
"Once rates stop rising, I think that could pave the way for upside in markets," said David Lefkowitz, head of U.S. equities at UBS Global Wealth Management.
The riskier and more volatile the assets, the bigger the fall. For example, small-cap growth mutual funds suffered the largest losses in October, tumbling 7.33%, versus a decline of just 1.68% for more stable and established large-cap growth funds, which include the megacap technology stock leaders.
Similarly, big ETF losers were semiconductor funds. iShares Semiconductor fared the worst, shedding 6.6%. Funds that invest in early-stage companies also got slammed. ARK Next Generation Internet fell 4.39% and Renaissance IPO, which invests in recent initial public offerings, declined 6.92%.
October was all about limiting risk and defensive positioning. Gold funds, which investors typically turn to in volatile markets, were among the best-performing ETFs. VanEck Gold Trust was up 7.41%, Goldman Sachs Physical Gold rose 7.4%, and iShares Gold Trust surged 7.37%.
Keeping Volatility Down
Low-volatility funds also held up better than the broader stock indexes. Fidelity Low Volatility Factor ETF declined just 0.39% and Invesco S&P Low Volatility ETF, which invests in the 100 stocks in the S&P 500 with the lowest volatility over the past 12 months, slid 0.45%.
Bets against the bond market also proved profitable again in October. The biggest ETF bond fund winner was Simplify Interest Rate Hedge, which rallied 12.66% to extend its year-to-date gain to 51.80%.
In October all four major U.S. stock indexes finished lower. The small-cap Russell 2000 was the biggest loser for the third straight month, tumbling 6.88%. The tech-heavy Nasdaq fell 2.76%, the S&P 500 declined 2.1%, and the Dow Jones Industrial Average gave back 1.36%.
If there was an outlier in performance, it was the bullish performance of bitcoin. The Grayscale Bitcoin Trust ETF rallied 39.45%.
Hiding Out From Stock Market Volatility
In a market weighed down by higher borrowing costs, investors are erring on the side of caution and prefer hiding out in profitable, high-quality, lower-volatility names, says Koesterich. That's a big reason why Vanguard Mega Cap Growth ETF, which owns the big, dominant established technology companies, fared relatively well, sliding just 1.1% in October.
Heading into year-end, however, market players may turn their attention to rebounding earnings. Third-quarter S&P 500 profits are on track for a 3.4% gain, says FactSet. Those positive earnings follow three straight quarters of flat or declining profit growth.
Earnings estimates for 2024 currently range from 8.2% growth in the first quarter to 16.3% upside in the fourth quarter, says Lipper I/B/E/S data. And stock performance could follow earnings, says Koesterich.
"The market's expecting about 10% gains in earnings in 2024," said Koesterich. "If we see that validated in the numbers, that's certainly going to help the market."
Looking Out For Earnings
Lefkowitz of UBS says digging into company earnings will be key to finding winners. He notes that Visa, the credit card processing company whose business results offer good insights into the health of the consumer and the broader economy, just reported in-line profits for its fiscal 2023 year and offered solid guidance for the next 12 months.
Heading into year-end, Wall Street will be looking more at the economy and less at inflation, says Lefkowitz.
"The primary concern is still the growth outlook," said Lefkowitz.
Another plus would be if interest rates stabilize and the fast rate at which longer-dated Treasuries rose last month cools. "It's the rapid upward adjustments in rates that really dislocate the equity market," said Koesterich.
When it comes to year-end risks, Koesterich says too-strong economic growth that forces the Fed and the market to push interest rates higher could cause more downside. Another wild card, he says, is the possible expansion of the war in the Middle East.
Minding Interest Rates
On the interest rate front, fixed-income experts still insist that the Fed is near the end of its rate-tightening campaign. "We do think we're getting very close to the Fed wrapping up," said Anders Persson, chief investment officer of global fixed income at Nuveen. Persson is betting the Fed is either done or has just one more hike in its inflation-fighting tool kit.
And in a world where yields are either stabilizing or inching down, the starting point of yields for investors putting fresh money to work remains attractive. "The vast majority of your investment returns in bonds come from income; it doesn't come from capital appreciation," said Persson.
Still, there is an opportunity to benefit from capital appreciation if interest rates begin to slowly head south, adds Persson. "Dollar-cost averaging into fixed-income makes a lot of sense at this point," said Persson. "The risk and reward is quite balanced compared to other asset classes. At some point in 2024, the Fed will start cutting rates and underlying yields will come down. And that's where you're going to start getting capital appreciation."
Bond investors right now should still clip bigger coupons offered by short-term bonds, but also make sure they start putting money to work in intermediate- and longer-term bonds that are now cheap and will benefit more when rates start to come down, says Persson. You don't want to stay all-in on short-duration bonds and wake up months down the road and realize you're earning just 3% on your fixed-income portfolio, not the 5% you've become accustomed to.
Stock Market: Sticking With High Quality
Since the economic outlook remains cloudy and the market remains in a late-cycle scenario, Lefkowitz advises investors to focus on quality and not go too far out on the equity risk spectrum.
"By quality I mean companies that have strong balance sheets, generate high returns on capital and generate consistent earnings growth," said Lefkowitz. "Some combination of those traits is probably going to be the place to be."
From a sector perspective, Lefkowitz likes energy, especially since the recent price pullback. "It's a bit of a hedge in case things really escalate in the Middle East," Lefkowitz said.
Playing It Safe
Having some exposure to defensive sectors, such as consumer staples, makes sense, especially if rates fall, which will make valuations more attractive, Lefkowitz says.
With war raging in the Middle East, getting exposure to U.S. defense stocks could prove profitable. "They're arguably in a pretty good position given what's going on in the world." Last month, SPDR S&P Aerospace & Defense ETF gained 2.69%.
The bottom line is the outlook for stocks could brighten if interest rate volatility calms down.
"I think the risk reward (for stocks) is getting more interesting," Lefkowitz said. UBS' year-end 2024 price target is 4,700, or about 8% higher than current levels.
