October has a reputation for being a difficult month for the stock market: the crash of 1929 occurred in October, as did the crash of 1987. Although there was no crash this October, it was still a challenging month for investors. Major equity indices were down mid to high single digits, and emerging markets and small caps were worse. Even worse still, bond prices declined as rates rose a bit. There was really nowhere to hide but cash.
What’s notable, however, is that this difficult environment didn’t really coincide with a change in the data. Earnings were generally pretty good, as was the economic data. Right now, the difficulties we saw in October represented more of a change in sentiment – how people are interpreting the data – than a change in the actual environment. It’s important to note that the market is a forward-looking mechanism, so we’ll have to wait and see if this shifting sentiment accurately predicts something around the corner, and if so, what that something is.
For firmer clues about the future direction of the economy, we like to pay attention to the money markets and credit markets, even though it’s the stock market that typically gets the headlines. We like to see an upward slope to the yield curve and narrow spreads for risky borrowers. While the yield curve has flattened quite a bit over the last year, it has not yet inverted, and the credit markets continue to look healthy and liquid.