October 2016 Market Report

 

The polls got it all wrong. Wall Street got it all wrong too. The financial markets dubbed the potential election of Donald Trump a “black swan” event, meaning it was remotely possible but with potentially dire consequences. The predictions of market fallout were frightening, ranging from a drop of 11 to 13 percent in the S&P 500 index to a 2,000-point plunge in the Dow.

 

As election results were tallied, the predictions seemed to be coming true. The S&P 500 index futures plunged to hit a 5% overnight limit. The see-saw effects of panic caused US Treasury yields to plunge, with the 10-year note falling 17 basis points before surging 37 basis points. Gold prices soared more than 5% before falling nearly as much (gold is widely considered a safe haven in unstable markets).

 

But then the markets steadied. The day after the election, the S&P 500, Dow Jones and Nasdaq all gained more than 1%. Both the S&P 500 and the Nasdaq ended the week up 3.8%, and the Dow capped its election week rally with another record close and a weekly gain of 5.5%, its biggest in nearly five years. 

 

You know the old adage: the markets hate uncertainty. And there’s no doubt we are living in uncertain times. Mr. Trump’s policies are vague to say the least, and time will tell how they translate into law. The Republicans are now in the driver’s seat with control of the House and Senate, but their leader has no previous governing experience. It remains to be seen how it will all work out. 

 

As the dust settles, some investors are taking heart in Trump’s pro-business, anti-regulation, pro-growth stances. A big investment in infrastructure (something both Republicans and Democrats agree is needed) will provide jobs and economic stimulus. Promised tax cuts will free up more money for investment. But investor optimism is dimmed by Trump’s aggressive stances on immigration and trade, particularly if America engages in a trade war with China. Many predict rising interest rates and a surge in the federal deficit, two enemies of a growing economy. 

 

It’s impossible to predict economic outcomes for the Trump presidency. Markets could swing wildly in the next few weeks, or for the next four years, as we learn which of his campaign promises will be fulfilled. This begs the question of what investors should do right now. We have a lot to say on this issue, but let’s begin with pre-election October market results.

 

 

US MARKETS: The S&P 500 posted its third monthly decline after five months of gains (+12.49% cumulatively). For the month, the index was off -1.94%, its worst decline since the opening days of January 2016, when it fell -5.09% on its way to a -10.5% decline by Feb. 11, 2016. Year-to-date, the index was up 4.02% and 5.87% with dividends, averaging out to an annual rate of 4.83% and 7.06%, respectively. 

 

The S&P MidCap 400 posted a -2.76% decline in October, following a 0.80% September loss. Despite these losses, the index led the four major headline indexes for the year (7.93% YTD).

 

After eight months of gains (20.15% YTD), the S&P SmallCap 600 dropped -4.53% in October, the worst of the major US market indexes. The index had declined -6.22% during January’s market rout, following a -4.95% drop in December 2015. The net result of the ups and downs was still a decent 7.57% YTD gain, while the large-cap index was up 4.02% and mid-cap index was up 7.93%.

 

EMERGING MARKETS: Emerging markets continued their upward path, gaining 0.83% after a 0.91% gain in September and 3.23% gain in August. Twelve of the 22 markets were up. Brazil was again the standout, adding 13.74% for the month and tallying a gain of 82.34% YTD. However, the country remained in the red over the two-year period, down -14.20%. On the down side was the U.A.E., which fell -3.99% but was up 3.60% YTD, along with the Philippines, which fell -2.49% but remained up 6.45% YTD.

 

INTERNATIONAL DEVELOPED MARKETS: Developed markets did poorly in October, falling -2.29% after last month’s 0.53% gain. Only 3 of the 25 markets gained. Italy did the best for the month, up 1.91%, but remained deeply in the red, off -18.91% YTD. Spain gained 1.59% for the month but was down -2.48% YTD. Belgium did the worst in October, off -7.31%, with YTD results turning negative to -4.44%. The UK fell -5.79% as the pound declined, and was down -9.32% YTD. Year-to-date, global developed markets were up 2.03%, but excluding the US they were in the red, off -0.51%.

 

US ECONOMY: The US economy showed continued slow growth, led by housing, as earnings beat estimates. More important is that the earnings supported multiples, with Q4 2016 estimates holding up. 

 

The September employment report posted 156,000 net new jobs, few than the 168,000 new jobs that were expected. The unemployment rate increased from 4.9% to 5.0%, with the participation rate ticking up slightly from 62.8% to 62.9%.

 

YIELDS, RATES, AND COMMODITIES: The 10-year U.S. Treasury Bond closed at 1.84%, up from 1.60% at the end of September. This was the biggest monthly gain since June 2015. The 30-year U.S. Treasury Bond closed at 2.59%, up from September’s 2.32%. 

 

Currencies were active, as the euro closed at 1.0982, from last month’s 1.1240. The British pound sterling closed at 1.2244, from last month’s 1.2976. The yen declined to close at 104.81 from last month’s 101.34, and the yuan closed at 6.7716, from last month’s 6.6711. 

 

Oil was volatile, as the potential for an OPEC freeze temporarily pushed it to a 15-month high on hopes that the Nov. 30, 2016 OPEC meeting would bring some production limits. But concern over the ability to compromise on target dates limited the gains. Oil closed at 46.70, down -2.8% from September’s close. 

 

Meanwhile, gold declined -3.0% to USD $1,278.90 from September’s $1,318.80. 

 

 

We find timely advice in the annual DALBAR “Quantitative Analysis of Investor Behavior” (QAIB) report, which since 1994 has measured the effects of investor decisions to buy, sell and switch into and out of mutual funds. This year’s report covers a remarkable era of turbulence, looking back over 30 years from December 31, 2015 to include the crash of 1987, the dot-com swoon of 2000, the global market crash of 2008, and recovery periods of 2009, 2010 and 2012. 

 

DALBAR found that “a huge gap exists between what an investor should have earned from a representative group of investments (index) and the actual returns that an average investor received.” No surprise there. Over the 30 years ended December 31, 2015, the S&P 500 index produced an annual return of 10.35%, while the average equity mutual fund investor earned only 3.66%, a gap of -6.69 percentage points. That’s billions of dollars that could be in investors’ accounts, but isn’t. 

 

We’d love to blame this all on a greedy, deceptive and well-oiled financial industry. But it turns out that we have met the enemy, and it is us (with due credit to Oliver Hazard Perry and Pogo). The DALBAR report points to investors’ own behavior—namely panic selling, exuberant buying and attempts at market timing—as one of the leading causes of lousy financial results. 

 

Nine common behavioral culprits hurt investors the most. Among them: blindly following the herd (or being unduly influenced by the media), making decisions based on “narrow framing” without considering all implications, pursuing strategies based on loss aversion or past regrets (which is all too easy, given the turbulence investors have been through), or behaving with irrational optimism. 

 

Recognize your thought processes in any of this? The impulse to “do something” in times of uncertainty lurks within us all. It can take considerable discipline to avoid acting for the wrong reasons at the wrong time. 

 

The best way to fight off these self-defeating behaviors is sticking to a strategy built on your own personal goals with appropriate asset allocation and diversification for your specific needs and timeline. If you feel compelled to ratchet down risk, consider some form of portfolio protection like stable fixed income to limit losses during market turbulence.