Here’s a look at trends in October:
High quality companies performed much better than lower quality companies.
- Why? Lower qualities companies had a sharp rally in late September after the Fed held rates unchanged, but quality re-asserted itself firmly by the third week of October.
Lower quality bonds outperformed investment grade bonds this month.
- Why? Junk bond spreads peaked on October 2nd and contracted steadily throughout the month.
Capitalization-weighted indices beat equal-weighted indices with the same objective once again.
- Why? The trend towards large companies continues as larger companies typically have stronger balance sheets, allowing them to more effectively use leverage.
Asia outperformed Europe again, but both indices gained over 8%
- Why? More re-assuring news from China, more stimulus from the European Central Bank.
Frontier markets lagged emerging markets for the first time in several months.
- Why? Both gained, but neither rose nearly as much as developed markets.
Hedged foreign funds beat un-hedged foreign funds
- Why? The currency markets were volatile in October with the dollar losing ground after the weak U.S. employment report, then gaining strength on Draghi’s extension of QE in Europe and the Fed’s hawkish comments last week.
Small cap companies edged out mid-size companies in performance, but the difference was small.
As one might expect from a market up almost 9%, “risk on” industries materials, energy, and technology foremost crushed risk off industries.
Growth modestly outperformed value for the first time in three months. It appears as though the growth trend remains in place.
The trend continues.
The stock market failed to make new lows in September, signaling a possible bullish trend change. That change appears to have been confirmed in October as S&P 500 came very close to its all-time highs on Wednesday the 28th. (See Chart 1) The NASDAQ came even closer. (As of today, 11/2 the indices are again testing their all-time highs.) Price and breadth action argues for the market to go higher in the short term.
How do we interpret this?
If stocks would have gone on in September or October to fall below their August lows, it would have been a strong signal to us that the primary trend was bearish and that a more defensive posture was prudent. Obviously, that didn’t happen. We have experienced a nice recovery in October to the point that we are 2-3% from all-time highs. That puts us back where we were in July: a long-in-the-tooth bull market with fairly expensive valuations, interest rates that are likely to begin moving higher in the next couple of months and corporate profit margins showing signs of coming down from record levels. Many investment professionals wanted the market to retreat this past summer because we were uncomfortable investing new money at such lofty valuation levels. For better or worse, it is Groundhogs Day all over again.
I believe that a fair number of the pundits who keep arguing for the Fed to raise rates are thinking the same way, namely that we need to start having business cycles again. Yes, that would mean a more pronounced sell-off at some point, but it also means that rather than perpetual slow growth such that businesses fear to invest for the future, we would see both recessions and booms. Booms are essential for the success of deep cyclical industries like engineering, construction, and mining because it takes time for capital spending in these areas to pay off.
As I said, the bull market seems to have re-exerted itself. Best then to continue to play the current trend, investing in industries where the return on a dollar invested in the business is fairly immediate. That means consumer-oriented firms, technology firms, and those companies with the balance sheet flexibility to borrow at low rates to buy back enough stock to improve per share comparisons.
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