Markets Get Spooked in October
Hello again everyone! The CSUF Student Managed Investment Fund is back with another update for October. Enjoy the read!
We have begun preparing for the RFP competition on November 30. We will be competing against other universities in Southern California, including UC Irvine, Chapman University, Cal Poly Pomona, Cal State Long Beach, and UC Riverside. For those interested in attending, please mark this date on your calendar.
For those of you interested in joining SMIF next semester, classes/meetings will take place on Tuesdays or Thursdays from 10:00 am to 11:15 am. These will be two separate sections, so please arrange your schedules accordingly.
Portfolio Update (October 4 - November 3)
Since our last update in early October, our overall portfolio's performance dropped significantly to -0.12% returns for the year. Despite significant capital depreciation, the portfolio is still outperforming the benchmark by +49 bps. Please refer to the chart below for our performance throughout the period.
October Market Recap
A new wave of selling hit the record-long bull market in October as investors worried that the ideal Goldilocks climate they have enjoyed - a surging economy, low interest rates, and strong corporate profits - would soon be behind them. As a result, October experienced a highly volatile market. Overall, investors are growing more concerned about slowing domestic and global growth, potential policy missteps by the Federal Reserve, rising geopolitical tensions between the U.S. and its trade partners, upcoming midterm elections, and peaked asset valuations.
Strong Economic Numbers Continue...
Roughly 250,000 new jobs were made available to the labor market in the month of October. Wage growth also increased to a nine-year high of 3.1% relative to prior October monthly data while the unemployment rate held constant at 3.7% from a month earlier (the Fed estimates that a sustainable unemployment rate in the long-term is 4.5%). The Fed is concerned that rising wages and low unemployment are likely to cause labor shortages, resulting in higher wages and higher consumer prices that may cause inflation to overheat. This could push the Fed to lift interest rates more aggressively on their path to normalization, increasing the risk of the Fed pulling the economy into a recession.
Fed’s Belt Too Tight or Just Right?
Changes in interest rates can have both positive and negative effects on the U.S. markets. When the Fed changes the rate at which banks borrow money, a ripple effect is triggered across the entire economy. Rising interest rates affect consumer and business psychology. For instance, when interest rates rise, both businesses and consumers may cut back on spending and borrowing, causing earnings to fall and stock prices to drop.
Following the strong U.S. jobs report for the month of October, the Fed is determined to raise rates in December and throughout 2019. Last month, a large rise in U.S. Treasury yields pulled global bond yields higher across the board and boosted the dollar while stocks fell in response. The ten-year Treasury reached its seven-year high of 3.23% as comments from the latest Fed meeting signaled that more rate hikes are on the horizon. Strong U.S. economic figures are also causing markets to reassess how far the Fed's tightening plan will go, creating uncertainty in the market. There is also concern regarding the Fed tightening rates too quickly with the expected growth slowdown in Q4 2018 and 2019.
Ongoing Geopolitical Factors
President Trump’s trade war with China has increasingly preoccupied the markets. Official numbers released by Beijing in mid-October revealed that China’s economic growth slowed to 6.5%, its lowest level since 2009. The slowdown in China, the world’s second-largest economy, could mean falling sales for U.S. companies that export to that market. It is apparent that the enacted tariffs have affected China more greatly than the U.S. since China is more dependent on exports. This is also evidenced by the widening U.S. trade deficit.
Moreover, Trump has struck a new deal with its previous NAFTA trade partners, Canada and Mexico, under the new name USMCA. The new agreement outlines restrictions for industrial manufacturers and agricultural producers that rely on trade between the regions. However, the new deal still needs congressional approval, so ratification is not expected until next year. If Democrats manage to flip a majority of either congressional houses in the Legislative branch during these upcoming elections, the trade agreement and any future legislation could face further obstacles.
Midterm Elections: Who Will Seize Control of the Legislative Branch?
During the midpoint of each Presidents' four-year terms, the U.S. holds midterm elections. Unlike the economic indicators mentioned above, the outcome of these midterm elections do not necessarily indicate how well the economy is doing but rather points to the general direction of how certain legislation may impact the general direction of where economy is headed.
Recently, Republicans have been able to shift fiscal policy and legislation in their favor for the past few years. However, this might change after this upcoming midterm election. Historically, when one party has majority power in the House or Senate, control tends to shift towards the minority party during midterm elections due to a change in perception by voters and a more aggressive push by the lesser party to have a voice. The change in control will impact fiscal policy, how certain legislation is passed within the U.S government, and shift how money is allocated within the U.S economy, which will ultimately impact consumer confidence.
The past four years have been a wild ride in the U.S. in terms of changes in policy. With corporate taxes being cut, a 24-year-old NAFTA deal being revamped, indifferent views towards infrastructure, and an overall more laissez-faire type of governing, U.S citizens have recently been exposed to a unique environment. If Republicans remain in power, the U.S could see even more of a push in the economy; thus, further prolonging the recovery since the financial crisis. On the other end of the spectrum, if Republicans continue their actions, they could stimulate the economy at a time when drawbacks need to be implemented.
A change in power in the Legislative branch may bode well for the U.S economy. Perhaps Democrats in power will enable citizens' skepticism in the economy to sustain? One thing is for certain, these next few weeks are incredibly important and will play a large part in the state of the economy and country going forward.
Are We Over or Under the Hill?
With rising borrowing costs, investors have replaced their high-growth securities with safer long-term bonds that can provide more stable returns. Throughout the year, the leading stock performers have come from the Tech sector, especially the FAANG securities. However, Tech stocks were some of the worst performers in October and investors might be speculating if valuations for several of these securities are too high. In October, the Investor Confidence Index (ICI) dropped over 2.50 points which may be a result of concerns about peaked valuations.
Even the oil market has been infected by growth fears. Crude oil was at its four-year high due to sanctions on Iran’s exports. However, U.S. oil prices have plunged 11% in October while Brent crude oil dropped 9%, making October the worst month for both since July 2016. It appears the looming threats of an escalating trade war and rising rates have prompted investors to sell their holdings. Although both the equity markets and oil futures were both negatively affected by the October sell-off, stocks began to recover towards end of October while oil continued to fall over 2%. If trade tensions continue to rise, concerns about slower global economic growth may be realized which may impact the demand for oil.
The stock market has seen strong growth these last two years. In 2017, the VIX was at an all-time low and people that began investing during this time became accustomed to low volatility and positive returns on their stock investments. These millennial investors did not experience any significant market downturn until February 2018 when the S&P 500 was down 3.9%, breaking a ten-month positive return streak.
While volatility returned and these new investors were startled, the market returned back to its low volatility state. It wasn’t until this October when volatility surged and investors became concerned about their investments. The S&P 500 was down 6.9%, the biggest decline since September 2011.
During this kind of market turbulence, general investors may sell their holdings because they don’t want to lose their investment returns. This often proves to be a mistake since it is difficult to time the market, and now could be a good time to buy and hold.
Instead of celebrating strong earnings and promising economic indicators, investors have zeroed in on the potential risks to the economic and corporate profit outlook for the coming years. Expectations that the Fed will continue hiking interest rates and a clear economic slowdown in China as well as on a global scale could all eventually start to bite. On top of these reasons, investors may be more anxious about what the midterm elections could mean for their portfolios. As such, October saw a volatile market and November will be more telling on whether these concerns actually matter.
Our equity portfolio fell along with the overall stock market in October. All but two of our holdings saw negative returns, with TSN returning +2.1% and MPWR returning +0.1%. Please see the chart below for more information.
Our lowest fixed-income performer for the month of October was our high yield ETF, HYG -2.2%, and our top performer was our developed markets mutual fund, PFOAX +0.1%. Please see the chart below for the performance of our other bond funds.
Information and opinions contained in this article have been obtained or derived from sources believed to be reliable, but no guarantees can be made regarding accuracy of information provided by the original sources. All opinions expressed are subject to change without notice. This article is not tailored to the investment needs of any specific person and is provided for informational purposes only.