Stock Market Rebounds After September Sell-Off

Monthly Client Letter
Written By Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®
Fall leaves

Photo credit: GraceHues Photography, Unsplash

Monthly Market Summary

  • The S&P 500 Index returned +8.1% during October, underperforming the Russell 2000 Index’s +11.2% return.

  • Energy (+25%) was the top-performing sector as the price of oil rose +8.9%, with Industrials (+13.9%) and Financials (+11.9%) the second and third best performers. Defensive sectors underperformed the market rally during October, with Real Estate (+2%), Utilities (+1.9%), and Communication Services (+0.7%).

  • Corporate investment grade bonds generated a -0.7% total return, underperforming corporate high-yield bonds’ +3.3% total return.

  • The MSCI EAFE Index of global developed market stocks returned +5.9% during October, outperforming the MSCI Emerging Market Index’s -2% return.

Equity Market Rebounds After September Sell-Off

Stock markets remained volatile during October, once again changing direction as investors shifted their views. After declining -9.2% during September, the S&P 500 gained +8.1% during October. Likewise, the Russell 2000 Index of small-cap stocks reversed direction, returning +11.2% during October after declining -9.7% during September. High-yield corporate bonds outperformed in the credit market as credit spreads tightened, while investment-grade bonds produced a slight loss as Treasury yields continued to increase. Comparing September and October performance trends highlights the sharp reversal in market sentiment and the resulting risk-on market rally.

Market Returns for October 2022

Market Returns for October 2022

Source: MarketDesk, Data as of 10/31/2022

US Equity Sector Returns (October in %)

US Equity Sector Returns for October 2022

Source: MarketDesk, Data as of 10/31/2022

Uncertain Federal Reserve Policy Continues to Drive Market Volatility

Increased stock and bond market volatility is attributed to uncertain Federal Reserve policy.

Why?

The terminal rate, which represents the forecasted rate at which interest rate hikes will stop, constantly changes as new information is available. A higher terminal rate is more restrictive on economic activity and implies lower stock valuations, while a lower terminal rate is less economically restrictive and implies higher stock valuations. As the market’s terminal rate forecast moves up and down, stocks and bonds also move to reflect the new terminal rate.

The October equity market rally was driven by the concept of a ‘Fed pivot’, defined as a reversal in Federal Reserve policy.

Is the new projected terminal rate correct?

The pivot concept gained steam recently as Fed officials started to debate when and how to stop raising interest rates, which the market interpreted as fewer rate hikes and a lower terminal rate. Stocks traded higher as the market priced in a lower terminal rate. Until the direction of Fed policy is more evident, the market’s projected terminal rate will continue to fluctuate.

We expect market volatility to remain elevated in the coming months.

Actionable Advice

  • We expect market volatility to remain elevated in the coming months, and we advise investors to review their portfolio holdings.

  • Investors should consider large-cap value stocks with positive cash flow and pay dividends.

  • Investors should also consider stocks with lower or average price-earnings ratios (PE). The S&P 500 PE is currently at 18.5, so investors need to be mindful of growth stocks in their portfolio which can have a significantly higher PE.

  • Investors may want to consider lowering their portfolio’s sector weighting to the Technology sector. The S&P 500 Technology sector weight is at 25.42% vs. our current weight of 19%.

Our Insights

Featured
Election Driven Rally Pushes US Equities Higher
Election Driven Rally Pushes US Equities Higher

Stocks traded higher this week, with most of the gains occurring after the election. The S&P 500 reached a new all-time high, nearing the key 6,000 level. The broader equity market rally was notable as investors priced in the Trump administration’s pro-growth, reflationary policies. The past few weeks have been packed with market-moving events, but the calendar is expected to settle down as we approach year-end.

Treasury Yields Rise Following the Fed’s September Rate Cut
Treasury Yields Rise Following the Fed’s September Rate Cut

Stocks finished October lower as investors navigated Q3 earnings, the upcoming election, and uncertain Federal Reserve policy. Treasury yields climbed as investors considered the possibility that the Fed may not cut interest rates as much as previously expected. Concerns about fiscal spending also drove Treasury yields higher, with expectations for continued high government spending regardless of the election outcome.

The Next Two Weeks are Filled With Market-Moving Events
The Next Two Weeks are Filled With Market-Moving Events

This week, stocks traded lower after several weeks of consistent gains. The S&P 500 dropped -0.5%, underperforming the Nasdaq 100's +0.3% gain but outperforming the Russell 2000's -2.8% return. The Magnificent 7 rose over +2%, making Growth the only factor to trade higher. The next two weeks are filled with market-moving events, and once they pass, stocks could rally into year-end.

Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®

I am currently the Managing Partner for our independent investment advisory firm, Optima Capital Management. Together with my business partners, Todd Bendell CFP® and Clinton Steinhoff, we founded Optima Capital in 2019 as a forward-thinking wealth management firm that serves as an investment fiduciary and family office for high-net-worth individuals and families. In addition to being the Chief Compliance Officer, my role at Optima Capital is portfolio management. I have over 18 years of experience in managing investment strategies and portfolios. I specialize in using fundamental and technical analysis to build custom portfolios that utilize individual equities, bonds, and exchange-traded funds (ETFs). I began my financial services career with Merrill Lynch in 2003. At Merrill, I served in the leadership roles of Market Sales Manager and Senior Resident Director for the Scottsdale West Valley Market in Arizona. On Wall Street Magazine recognized me as one of the Top 100 Branch Managers in 2017. I am originally from Saginaw, Michigan, and a marketing graduate from the W.P. Carey School of Business at Arizona State University. I am a Certified Private Wealth Advisor® professional. The CPWA® certification program is an advanced credential created specifically for wealth managers who work with high net worth clients, focusing on the life cycle of wealth: accumulation, preservation, and distribution. In addition, I hold the following designations - Chartered Retirement Planning Counselor (CRPC®), Certified Divorce Financial Analyst (CDFA®), Certified Plan Fiduciary Advisor (CPFA), and Retirement Management Advisor (RMA®). In the community, I am a member of the Central Arizona Estate Planning Council (CAEPC) and serve as an alumni advisor and mentor to student organizations at Arizona State University. My interests include traveling, outdoors, fitness, leadership, entrepreneurship, minimalism, and computer science.

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