October 2023 Monthly Market Review

Domestic equity markets experienced a sell-off during October due to concerns about higher interest rates. However, corporate fundamentals remained strong, with many S&P 500 companies beating earnings expectations. Developed non-U.S. equities also declined, particularly in Europe and Japan, but there was optimism about cooling inflation. Emerging markets equities faced headwinds, especially in China, due to concerns about the property sector, economic recovery, and geopolitical risks. In fixed income, Treasury yields rose, and credit spreads widened. Real assets, including oil and natural gas, experienced price fluctuations. The clean energy sector saw poor performance. U.S. REITs declined, and infrastructure was negatively impacted by higher rates.

Equities

Domestic markets sold off for the third consecutive month as higher interest rates stoked fears of a hard economic landing.  The S&P 500 fell 2.1% for the month; by late October, it had entered correction territory.  Small cap  stocks, as measured by the  Russell 2000 Index, posted an even larger decline than their mid-cap and large-cap counterparts, falling 6.8% for the month. The October equity market drawdown was broad-based as utilities (+0.8%)—one of the more defensive sectors—was the only sector to finish the month in positive territory.

Despite weak investor sentiment, corporate fundamentals continued to improve.  Over 80% of the S&P 500 constituents with reported earnings beat consensus expectations, putting the Index on track to generate positive year-over-year earnings growth.  At the month-end, the S&P 500 traded at a 17.3x forward multiple, slightly below its 10-year average of 17.5x.

Developed non-U.S. equities declined 4.1%, with weakness widespread across regions.  In Europe (−3.7%), the Eurozone economy remained stagnant with further weakness in business and manufacturing activity during the month.  However, there was optimism around cooling inflation, which hit a two-year low.  Japan (−4.5%) improved toward the end of the month after the Bank of Japan (BOJ) said it would allow more flexibility in its yield curve control policy.  The yen (−1.5%) remained weak relative to the USD, which factored into the BOJ’s decision.  Currency movements on the whole were a headwind as the MSCI EAFE Index was roughly 70 bps higher in local terms.

Emerging markets equities fell 3.9% (USD).  Headwinds persisted in China (−4.3%), where the CSI 300 Index, a measure of the top 300 stocks listed on the Shanghai and Shenzhen Stock Exchanges, hit a pre-pandemic low after falling nearly 40% from its 2021 peak.  Reports showing better-than-expected growth in the third quarter were released in late October but the upside surprise in growth was not enough to stall the equity market sell-off as investors remain focused on turmoil in the property sector, a fragile economic recovery, and heightened geopolitical risks.

Elsewhere, India (−2.9%) reversed course from the previous month.  Mixed earnings results combined with rising oil prices and tight global financial conditions caused heightened uncertainty surrounding the sustainability of the country’s economic growth momentum.  India imports approximately 80% of its oil, which means it is vulnerable to the impact of Middle East tension on energy prices.

Fixed Income

Financing the deficit continued to be in the forefront of investors’ minds.  Treasury yields from the three-month to the two-year points on the curve trickled higher by a few basis points, but the long-end of the curve saw more dramatic moves with the 10-year rising 33 bps to 4.9% and the 30-year rising 36 bps to 5.1%.  The 10-year Treasury briefly pierced 5% in October, but experienced a late-month rally as the Treasury Department released issuance plans for the next quarter that were lower than markets expected.  However, the damage was already done and both the intermediate-term (−1.4%) and long-end of the curve (−4.9%) lagged T-bills and front-end Treasuries.

Credit spreads widened with high yield rising 43 bps to 437 bps and investment-grade corporates increasing 8 bps to 129 bps.  Securitized assets also increased with MBS, CMBS, and ABS rising 9, 10, and 11 bps, respectively.  Rising yields and wider spreads led to negative performance across spread sectors, with investment-grade corporates, high yield corporates, and securitized assets dropping between 1.2% and 2.0%.

Real Assets

Real assets were down for the third straight month.  U.S. REITs declined 4.5% as Treasuries hit new highs.  Headlines about stressed/distressed assets were pervasive amid a difficult financing environment, with U.S. office REITs falling 9.8%.  October’s declines brought YTD returns in the office sector to −25.5%.  Data center REITs, the top performing REIT sector YTD (+17.9%), was one of the few REIT sectors to see positive returns (+1.3%).  Global REITs fell 4.8%.  Infrastructure (−3.0%) was also negatively impacted by higher rates.

After a strong rally in the third quarter, the price of Brent crude fell 7.8%.  Prices initially spiked following the start of the Israel-Hamas war due to generalized uncertainty in the Middle East.  However, prices cooled in the following days as there was no immediate disruption to supply.  Iran has sidestepped recent U.S. and European sanctions, bringing oil supply to the global market, which helped moderate prices.  If these sanctions are more strictly enforced, the global oil supply should decline and prices could rise.

Resource equities (−4.0%) were down on the dip in oil prices.  Natural gas prices surged 33.5%, most of which occurred in the final week of the month as forecasts called for a slightly colder winter than initially expected.  While natural gas is up 1.6% YTD, it is down 28.7% year-over-year after an extended period of elevated prices following Russia’s invasion of Ukraine.  Two of the oil industry’s largest companies made blockbuster acquisitions during the month, with Exxon acquiring Pioneer Natural Resources for $60 billion, and Chevron acquiring Hess for $53 billion.  These moves represent a larger consolidation theme within the oil industry.  For most of 2023, oil companies have exercised discipline, focusing more on returns and capital efficiency and less on production, which led to a supply decline.  To replenish supplies, the companies looked at Western acquisition targets due to perceived risks overseas.  Exxon and Chevron have resources to enhance their recently acquired drilling infrastructure, allowing for greater overall extraction from existing wells in a maturing industry.

Clean energy fell 11.3%, bringing losses to 29.0% over the trailing three-month period and 34.3% YTD.  Clean energy valuations are now in line with July 2020 prices—before the industry saw the bulk of its 141.3% gain in 2020.  Factors impacting valuations include increased financing costs, which diminish the value of future cash flows.  A stream of poor earnings reports have also weakened investor sentiment after the highs of President Biden’s election and the Inflation Reduction Act announcements.  Many investors now appear to be more focused on AI and infrastructure plays.  A number of offshore wind projects off New York, Britain, the Netherlands and Norway have been shelved due to financing costs.  Additionally, many solar companies are tied to the semiconductor industry and supply chains have been impacted by geopolitical tensions and uncertainty over the future of Taiwan.

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