October 2023: Resilient economy but weak markets
October at a glance
- October markets reflected continued uncertainty about the path of inflation and the economy.
- Increased global tensions from the Israel-Hamas war adds to market uncertainty.
- Equity markets weakened across the board in October, extending losses posted in Q3
- The Fed kept policy rates unchanged, but longer term interest rates rose steadily during the month, hurting fixed income returns in all but ultra short treasuries.
Resilient economy but weak markets
The fourth quarter began as the third quarter ended with stocks and bonds falling broadly. Rising interest rates, driven by Fed comments on a continued tight policy stance, persistently strong economic activity, expected large treasury debt issuance in the coming months and heightened global tensions from the Israel-Hamas war, had investors in a more risk-off mood. Inflation signals continued to moderate, with the core personal consumption price index up 3.7% in the latest release for September, down from 3.9% in August.1 Still, inflation remains well above the Fed’s 2% target. After the Fed’s November 1st meeting, Chairman Powell once again indicated that monetary policy will remain tight until inflation moves closer to their 2 percent target, with no expectation of rate cuts anytime soon and a continuation of the shrinking of the Fed’s securities holdings “at a brisk pace”.2 Part of the Fed’s challenge is that economic conditions keep surprising to the upside, with estimated Q3 real GDP up 4.9% on the back of a surge in consumer spending.3 While the still robust economy bodes well for corporate earnings bottoming this quarter, the Fed’s stance on tighter monetary policy continues to cloud the outlook for investors.
A broad sell-off in equities
- Equity markets declined across the board in October, with the S&P 500 down for a third consecutive month, something that hasn’t happened since 2020.4
- The Dow and S&P 500 Value fell the least during the month, but are still well behind other parts of the US large stock segment.
- Small cap stocks, both in the US and internationally, continued to lag and are now negative for the year. 5
- Most industry sectors fell during the quarter. 6
- Utilities were the only sector to post positive returns in October, but are still down over 15% for the year.
- Energy stocks fell 6.08% for the month, reversing large gains in the third quarter.
- Only three S&P 500 sectors are now positive for the year: Communications Services (+36.64%), Information Technology (+33.67%) and Consumer Discretionary (+20.04%)
- Equity returns were even weaker outside of the US, with developed international stocks down over 4% for the month.7
Source: S&P Dow Jones Indices8, NASDAQ9
Rising rates for longer duration fixed income
- The Fed held policy rates steady at their November 1st meeting, but longer-term rates continued to move higher.
- Fixed income returns were negative in all segments except ultra short term Treasury bills.10
- The 10-year treasury yield rose 29 basis points in October and briefly topped 5% in October. 11
- The 2-year yield rose just 4 basis points during the month .12
- The larger rise in long-term rates further reduced the “inverted yield curve” measure (when 10-year treasury yields are less than 2-year yields) to just -19 basis points at the end of October, the lowest negative spread since July 2022.13
Source: S&P Dow Jones Indices
The challenge of the Fed’s “dual mandate”
At his November 1st press conference, Chairman Powell noted that, “My colleagues and I remain squarely focused on our dual mandate to promote maximum employment and stable prices for the American people.”14 The full articulation of these dual objectives came in the aftermath of the Great Depression and WWII as Congress was looking for policies to promote greater economic stability. The Employment Act of 1946 set forth that the Federal Government's role was “...to promote maximum employment, production, and purchasing power.”15 The Fed saw itself as part of this mandate. The goal is not controversial, but achieving it can present challenges as the tradeoff between growth and price stability is sometimes at odds, and the economic models that predict these dimensions are far from perfect.This challenge was especially evident during the late 1960s and 1970s “Great Inflation” period, when the balance between inflation and unemployment did not behave as economic theory would have predicted.
Source: Bureau of Labor Statistics, Federal Reserve Bank of Minneapolis
During the Global Financial Crisis in 2008-09, then Fed Chairman Ben Bernanke was determined not to let the “Great Recession” turn into another Great Depression, aggressively employing policy tools to boost economic growth. Today, Chairman Powell seems equally set on not allowing the current period to repeat the 1970s Great Inflation. Inflation has indeed come down from the highs hit in 2022 but is still well above the Fed’s stated 2% target as labor markets remain tight and consumers keep spending. As Paul Volcker did in the late 1970s, Powell continues reiterating the Fed’s commitment to tighter monetary policy to achieve the Fed’s inflation target, even if that causes a recession like in the early 1980s. Powell is undoubtedly seeking to regain the credibility the Fed may have lost over the past several years.
The position we find ourselves in today is a result of a combination of these forces: the continued effects of the non standard quantitative easing policies put in place during the Great Recession that sought to keep that period from turning into another Great Depression, the immediate and protracted expansionary monetary and fiscal policies in response to the COVID pandemic; and imperfect forecasting models that underestimated the persistence of inflation. Combining this with the usual challenges of communicating these complexities results in the kind of uncertainty we see today.
15 Santoni, G.J. “The Employment Act of 1946: Some History Notes.” Federal Reserve Bank of St. Louis Review 68 (November 1986): 5-16.)