A dismal second half to October for equities led to another month of decline across the major equity indices amidst high volatility triggered by sharp ascents in bond yields, even as earnings season started strongly in the US.
The sentiment around interest rates and the expectation of elevated rates sticking around for longer than anticipated has darkened the outlook for equities as we approach the end of the year.
The first half of the year saw surges in the major US equity indices powered by a surge in price by the ‘magnificent seven’ mega-cap technology stocks. However, even positive earnings reports from magnificent seven components Amazon and Meta combined with better-than-expected US economic data couldn’t prevent the third straight month of decline in the S&P500 and NASDAQ indexes. S&P500 companies reporting positive earnings surprises for the third quarter have seen their shares decline by an average of 1%, compared to a five-year average of a 0.9% increase, highlighting the role concerns over bond yields and the impact of interest rates have played in the performance of equities. The decline in US equities was mirrored globally, with the FTSE100 just under 3%, the STOXX Europe 600 down over 3.50% and the Nikkei 225 down over 3% as of October 30th.
After a prolonged period of interest rates sitting at near-zero levels, the recent rapid rise of interest rates has brought a renewed focus on the fixed-income markets, with yields in major markets becoming increasingly appetising to investors. The yield on 10-year US treasuries briefly breached 5% on the 20th of October and stood at 4.85% as of the 30th of October, and the 2-year US treasury yield stood at just over 5%. These attractive yields have heaped pressure on dividend-paying stocks as treasuries now yield approximately the same as the top 20% of S&P500 dividend payers, as per research from Goldman Sachs. With investors able to generate the same level of yield through treasuries considered to be risk-free, the risk of holding equities, we have seen outflows in funds targeting dividend-yielding stocks more than double the outflow of the broader market this year.
The yield on 10-year UK Gilts sits at 4.55%, and the 2-year yield at 4.72%. Evidence suggests investor appetite for fixed-income is increasing despite a rout in bond prices as yields spike. Data on fixed-income ETFs listed in the US and Europe showed record inflows across the first 3 quarters of 2023. With interest rates anticipated to stay higher for longer on the back of stronger-than-expected economic figures, this trend would be expected to continue.
The European Central Bank opted to keep interest rates at 4.50% on October 26th after surprising the markets with a 0.25% hike in September. The Federal Reserve and Bank of England will announce their interest rate decisions at the beginning of November; both are projected to hold rates steady at 5.50% and 5.25%, respectively. The focus will instead be on any hints regarding potential future rate rises, something which either central bank has not ruled out. The US economy has been more resilient than forecasted, and inflation has started to creep back up from lows of 3% to 3.7%, yet currently, futures markets are pricing in a roughly 20% chance of an increase in rates in December. In the UK, inflation has been more persistent than in other comparable economies, and there are signs that the UK economy is beginning to slow. The swap markets currently place a probability of 33% that we will see another hike by the Bank of England by February 2024.
Cryptocurrency is an asset class that divides opinion, with some investors completely infatuated with the explosive historical returns and upside potential, while other investors would suggest even referring to it as an asset class is generous and consider it un-investable for a myriad of reasons, including extreme volatility and lack of regulation. After a disastrous 2022, the cryptocurrency markets have rebounded in 2023, with Bitcoin up over 100% year-to-date and Ethereum up over 50% year-to-date. If this trend continues, we could see another crypto-mania sweep the financial markets with investors piling into the asset class, hopefully, this time without millions being spent on monkey picture NFTs.
November and December have historically been some of the best months for the equity markets. After a poor last 3 months for the equity markets, investors will be hopeful history repeats itself, and an end-of-year rally similar to the surge we saw in the first half of 2023 arrives, ending the downward trend as we head into the new year.