Equity market gains were broad-based in October, driven by rising optimism regarding tax stimulus and recent favorable corporate earnings trends. Technology was a positive contributor across regional equity indices on the heels of further gains from several mega cap stocks. The U.S. dollar rallied, but local equity market strength outweighed the currency headwind in most countries. The U.S. equity market reached record highs once again, as the S&P 500 posted its 12th consecutive monthly gain, rising 2.3%. In the 20 months since February 2016, the only month of negative performance was the 1.8% decline in October 2016.
Gains were largely attributable to technology (+7.8%) as the sector widened its performance gap versus the rest of the market. Technology returns were driven by top index constituents Apple (+9.7%) and Microsoft (+11.7%), while Intel (+19.5%) surged late in the month on favorable earnings. Strength in technology and, to a lesser degree, financials (+2.9%) more than offset declines across telecom (−7.6%), consumer staples (−1.4%), energy (−0.7%), and health care (−0.8%). Telecom, which comprises only three stocks, was hurt by AT&T (−14.1%) due the weakness in its pay-TV business.
On the strength of October results, technology was up 37.2% YTD, accounting for nearly half of the S&P 500’s 16.9% gain. Strength within the sector has been broad-based YTD, with key contributors including Facebook (+56.5%) and Apple (+46.0%). At the end of the month, technology represented more than 24% of S&P 500 assets. Aside from the period leading up to the tech bubble, this represents the highest weight for any sector dating back to the establishment of the current sector classifications by Standard & Poor’s in 1989. Technology peaked at 34% of the S&P 500 in March 2000 before falling below 15%—the long-term average sector exposure in the Index—in late 2002. The only other sector to ever breach the 20% threshold was financials, which reached 22% just prior to the financial crisis before falling below 9% in March 2009. With technology dominating YTD gains, materials (+20.3%) and health care (+19.4%) were the only other sectors ahead of the broader benchmark in 2017.
The strength of tech names has also had a pronounced impact on emerging markets (EM). The MSCI EM Index (+3.5%) again outpaced its developed equity market counterparts in October, bringing YTD gains to 32.3%—far ahead of the U.S. (+16.9%) and developed foreign markets (+21.8%). Leadership within EM over both periods has been narrow, with tech names, particularly Chinese internet names, accounting for an outsized portion of the positive performance. Within EM, technology gained 6.8% for the month, led by strong gains from large constituents such as Taiwan Semiconductor (+12.9%), Samsung Electronics (+9.8%), and Alibaba (+7.1%). While most sectors within EM were positive for the month, technology accounted for more than half of the benchmark’s return.
The strength of technology within EM has persisted throughout 2017. The EM technology sector has gained 60.2% for the YTD period, accounting for 40% of the total benchmark return. These gains are attributable in large part to Chinese e-commerce names Alibaba (+110.6%) and Tencent (+83.3%). The narrow leadership of the market and the strong performance of the largest index constituents have resulted in a challenging environment for active management. The market has been particularly difficult for value-oriented managers, which generally have limited exposure to those names. The MSCI EM Value Index gained only 23.9% YTD, while the MSCI EM Growth Index has rallied 41.0%.
Within developed foreign markets, the 1.5% gain during the month was once again helped by strength in the technology sector (+4.9%). However, the bigger story was the rally in Japanese equities. The Nikkei 225 gained 8.2% and posted positive returns for 16 consecutive days, the longest streak on record. The rally began early in the month on the back of strong corporate earnings. Bullish sentiment was further fueled by Prime Minister Shinzo Abe’s landslide victory in Japan’s general election. The victory put Abe on track to become Japan’s longest-serving prime minister, and allows him to continue pursuing economic policy and reform.
The U.S. dollar rose against all major developed market currencies and a large number of EM currencies during October. However, outside of a 2.2% gain in the South Korean won, the increase in the EM currencies that rose against the dollar was modest. The strength in the U.S. dollar, in conjunction with rising commodity prices and the modest widening of U.S. TIPS breakeven levels, suggests that inflation expectations rose modestly in October. In the U.S., the GOP needs a legislative win before campaigning for the 2018 mid-term elections begins. With setbacks on immigration and the failure to repeal and replace the Affordable Care Act, markets increasingly appear to expect that tax-related fiscal stimulus will be signed into law in some form.
Much of the gain in the U.S. dollar occurred during the last week of the month, coinciding with the House narrowly passing the Senate’s 2018 federal budget. The Senate’s budget, which was passed along party lines in late September, allows for a $1.5 trillion increase in the deficit over the next 10 years for tax cuts. By passing the Senate’s budget, the House accomplished two goals: First, it created the conditions necessary for the budget reconciliation process to be used, which in turn will allow Senate Republicans to bypass Democrats and pass tax reform with a simple majority vote. Second, it allowed the House Ways and Means Committee to focus on drafting a tax reform bill, which the House hopes to introduce in early November.