Survival of the fittest

October was not a good month for stocks or bonds. The MSCI World fell 0.9%, while the Bloomberg Global Aggregate fell 3.4% over the month. A string of stronger than expected U.S. economic data helped dial back markets’ view on both recession risk and policy easing from the U.S. Federal Reserve (Fed), pushing bond yields higher. U.S. equities broke the winning streak and fell over the month for the first time since April. Market pricing on the Fed’s policy rate path also shifted, with risk skewed towards delivering a smaller-than-25 basis points (bps) cut at the November meeting, compared to a larger-than-25 bps cut a month ago.

Corporate fundamentals also reflect the ongoing strength of the U.S. 63% of the S&P 500 constituents have reported 3Q earnings at the time of writing. The beat/miss ratio currently stands at 69%/25%, led by technology and financial names. At current consensus estimates, U.S. equities are projected to have a healthy 14.2% year-over-year (y/y) earnings growth and 7.3% y/y revenue growth over 3Q.

Outside of the U.S., concerns on the growth outlook are rising, most notably in Europe, where incoming data from business surveys and the European Central Bank (ECB) suggests a sharper slowdown in economic activity. While ECB president Lagarde reiterated at the October meeting that the region is not sliding into recession, current environment has prompted a greater urgency for the ECB to accelerate upcoming interest rate cuts. Against a slower rate cut expectation in the U.S., the euro saw a steep decline of 2.7% versus the U.S. dollar.

Following the guidance provided in late September, China also lowered various key rates to support domestic activity and confidence. Further announcements were made in October, focused on long-term structural repairs such as raising the debt ceiling to alleviate local governments’ debt burden, expanding the property projects whitelist, and utilising special local government bonds to support housing de-stocking. These announcements have fallen short of market expectations for a large fiscal stimulus injection and Chinese equities markets were in reverse. Although the latest economic data suggests a marginal improvement, upcoming data will be crucial in assessing if the economy has bottomed out.

U.S. equities appeared a bright spot in October. Given current valuations and an event-packed month ahead (U.S. elections and the Fed’s decision), investors may be tempted to time the market until volatility fades. However, with history suggesting that elections seldom derail financial markets, taking advantage of the falling stock-bond correlation through a diversified portfolio could be a more informed approach to navigating the uncertainty ahead.

Australian economy:

• The third quarter consumer price index report was very close to expectations, and the annual rate of inflation dropped to 2.8% y/y. This put headline inflation back in the  Reserve Bank of Australia (RBA) target band for the first time since 2021. However, the distortions from government subsidies were very clear as the trimmed mean rate of inflation was 3.5% y/y. The broader details illustrated a further narrowing of the sources of inflation pressure, which is encouraging. However, inflation is moving very much in line with RBA forecasts, suggesting little need to deviate from the current policy settings.
  (GTM AUS page 5)
• Labour market report was strong again in September as the unemployment rate held steady at 4.1%. This means the unemployment rate has risen 0.6% off its cycle low, but it’s still a full 1.0% lower than the pre-COVID rate. While there has been some softness in demand, it is the rise in supply of labour that is driving the direction of the unemployment rate. The participation rate hit a new all-time high of 67.2%.
  (GTM AUS page 9) 
• Retail sales growth was a muted 0.1% month-over-month (m/m) or 2.3% y/y in September. However, the momentum in retail sales is still improving over the past few months.
• House price growth slowed further in October and exhibited a wide divergence across cities. Nationally, house prices rose by 0.2% m/m and annual growth fell to 5.9%. Prices in Sydney and Melbourne fell 0.1% m/m. Meanwhile, prices rose strongly in Brisbane (0.7% m/m) and Perth (1.4% m/m). Auction clearance rates fell below 60% for the first time this year. Historically this has been the level of activity at which house price growth remains flat.
  (GTM AUS page 10)
• Residential approvals bounced in September by 4.4% m/m, ahead of expectations. Meanwhile, housing credit growth picked up to 0.5% m/m, as both investor and owner-occupied credit increased. This reversed the prior month decline that pointed towards households opting to pay down debt faster, but this now looks less likely.
  (GTM AUS page 11) 
  

Equities:

• The ASX 200 fell 1.3% in October, lagging most other developed markets. The U.S. was down 0.9%, while Europe fell 2.8%, and Japan rose 1.9% over the month. Weaker economic data in Europe weighed on equity returns, while the positioning in the U.S. ahead of the elections may be responsible for the softer market.
  (GTM AUS page 34)
• At the sector level, eight of the ASX 200 sectors were in the red for the month. Utilities (-7.2%) was the worst performer, followed by consumer staples (-7.0%), materials (-5.2%) and energy (-5.0%). Offsetting this was the 3.3% rise in financials (all total returns in local currency).
• Valuations came down a little over the month to 18.1x forward price-to-earnings (P/E) ratio on the ASX 200 and 21.7x on the U.S. S&P 500. However, overall valuations remain full across most markets. Europe, Japan and emerging market equities are trading closer to long-run averages.
  (GTM AUS page 35)

Fixed income:

• Government bond yields moved up aggressively over October, as investors weighed the outlook for inflation and growth after the U.S. elections. The high correlation between U.S. and Australian government bonds yields meant the rise in the U.S. dragged local yields higher. The Australian 10-year bond yield rose 53 basis points (bps) to 4.51%, while U.S. 10-year yields rose to 4.28% or 50 bps higher.
  (GTM AUS page 50)
• Credit markets suffered along with equities as rise in yields pushed prices lower. Despite narrowed spreads, U.S. investment grades and high yields have returned -2.4% and -0.5%, respectively.
  (GTM AUS page 53)

Other assets:

• The Bloomberg Commodities index fell 2.2% over the month, as energy prices fell. Brent crude fell 2.3% to USD 72.57 per barrel as concerns around an expansion of the conflict in the Middle East faded and there is ample supply from other major producers, such as Saudi Arabia, to offset potential capacity constraints.
  (GTM AUS page 64)
• The U.S. dollar strengthened over the month as investors weighed the outlook for both the interest rate differential and the growth differential between the U.S. and the rest of the world. The DXY was 3.1% higher over the month with large gains against the Japanese yen (+6.5%), the British pound (4.2%) and the euro (2.7%). The lowering of Fed rate cut expectations and the likely need for more aggressive easing policy in the UK and across the eurozone weighed on the euro and the pound. The outcome of Japan’s lower house election meant that the Bank of Japan may delay further rate hikes until market volatility is lower. The Australian dollar fell by 5.6% versus the greenback to USD 0.655, reflecting the negative sentiment towards global growth and the shift in Fed rate views.
  (GTM AUS page 69)