Highlights:
- The S&P 500 Index slipped by -0.9% in October, with no clear leadership in stock categories.
- General economic news was strong last month, with inflation nearing the Fed’s 2% target, unemployment remaining low, and a solid Q3 GDP estimate of 2.8%.
- Despite a recent Fed rate cut, long-term rates rose, with the 10-year Treasury yield moving from 3.7% in mid-September to 4.2% by the end of October.
- Small, steady Fed rate reductions are expected, with another 50 basis points of cuts by year-end.
The stock market showed a touch of pre-election uncertainty in October, with the S&P 500 Index slipping -0.9%. Results were mixed with no clear leadership in terms of stock categories. In general, mega caps underperformed, with concerns over valuation and the prospect that returns on massive AI spending might take more time than anticipated. The general economic news was strong. Reports towards the end of the month showed inflation edging toward the Fed's target of 2% while the unemployment rate remained near historic lows. The early GDP estimate for the third quarter was a solid 2.8% while corporate earnings continued to produce, although in aggregate, not pacing the S&P's year-to-date advance of 21%. Considering the lackluster stock market in October, the more interesting story turned out to be the bond market.
When the Federal Reserve cut interest rates by 50 basis points on September 18, there was an expectation that we would be entering a period of broadly lower rates. Instead, we've reinforced the lesson that the Fed can only control short-term rates, as the bellwether 10-Year Treasury rate moved from 3.7% in mid-September to 4.2% by the end of October. This quashed any hopes for an immediate improvement in the housing market as the average 30-year mortgage rate moved up from 6.3% to near 7% by month end. Not only do high mortgage rates increase the effective cost of housing, but they also suppress supply as owners with low-rate mortgages are disincentivized to move. Higher Treasury rates also weigh on the federal deficit as debt issuance becomes more expensive.
Higher long-term rates can imply expectations of rising inflation, a possibility stoked by presidential candidate spending promises and policies, which might include higher tariffs and workplace-disrupting immigration policies. While it's worth celebrating what now appears to be the Fed's successful soft landing, the strength of the economy is also a potential source of re-inflation. At the same time, the spending projections for both candidates had bond buyers concerned over the prospect of expanding deficits.
Expectations remain for small but steady rate reductions by the Fed with another 50 basis points of cuts by year end. For the 2024 stock market rally to continue, it will have to overcome the attraction of higher bond yields and shrug off what appears to be historically high price-to-earnings (P/E) valuations. Looking ahead, presidential policies and the need to replace or renew the current tax code, which expires late next year, inject considerable uncertainties into the market. The prospect of higher capital gains rates could spark a late-year selloff, while any successful deficit reduction would require cuts in entitlement spending and/or tax increases. Within the stock market, we continue to search for companies trading at reasonable valuations whose businesses are less likely to be impacted by policy shifts in Washington.