October 2022 Monthly Market Review
Aside from weakness in emerging markets (EM) equities, October was positive for risk assets. U.S. and international developed equity markets delivered mid- to high-single-digit returns despite the persistence of concerning factors such as geopolitical risk (war in Ukraine, turmoil in the U.K, authoritarianism), aggressive central bank tightening, and ongoing global inflationary pressures. U.S. equities bounced back from oversold levels and outperformed international developed equities even with a weak U.S. dollar (USD) serving as a tailwind to non-U.S. assets. With inflation continuing to run hot, most real asset categories performed well, particularly those linked to rising oil prices. Lastly, the inflation dynamics continued to point to further large rate hikes by the Fed, which negatively impacted fixed income markets with the exception of those rated below investment grade.
Within EM (–3.1%), all eyes were on China (–16.8%) as investors digested mounting geopolitical headlines. The month started with the U.S. announcing semiconductor export restrictions aimed at limiting Chinese progress in advanced technology. The news hit the semiconductor sector at a low point in its demand cycle and sent global semiconductor stocks tumbling. Markets also reacted negatively to China’s Party Congress, where President Xi Jinping secured a third term as party leader. In doing so, he also further consolidated his power, which sent chills through the markets as investors questioned his dedication to economic growth and willingness to ease his economically destructive policies. Hong Kong’s Hang Seng Index fell 6.4% on the first trading day following the completion of the Party Congress—the worst single-day decline since the financial crisis. Internet- and e-commerce-related businesses, which have been in the crosshairs of regulatory crackdowns, were among those hardest hit.
Brazil (+8.6%) rallied during the month despite a controversial presidential election. Former President Luis Inacio Lula da Silva (“Lula”), who was jailed on corruption charges after two terms (2003-2010), defeated incumbent President Jair Bolsonaro in a run-off election at month-end. Lula was elected on a leftist agenda, but offered little insight during his candidacy as to his economic policy. Bolsonaro had been highly vocal claiming the election process was fraudulent, leading to concerns that the transition of power could be contested and lead to heightened market volatility. Markets did not move meaningfully post-election, suggesting that risk was largely priced in.
After reaching bear market lows in mid-October, domestic equities rebounded sharply, closing out the month with strong gains. Both the S&P 500 and broader Russell 3000 Index returned just over 8%. The rally could be attributed to very negative sentiment at the lows and the earnings surprises relative to scaled-down consensus expectations. Energy (+24.1%) was once again the best performing sector amid Organization of the Petroleum Exporting Countries (OPEC) production cuts. Industrials (+13.1%) and financials (+12.1%) also posted double-digit gains. The communications services (+0.6%) and consumer discretionary (+1.8%) sectors were the two worst performers, held down by drawdowns from mega caps Meta Platforms (–31.3%), Tesla (–14.2%), and Amazon (–9.4%). In a leadership reversal from prior years, only one FAANGM company, Apple, outpaced the S&P 500 year-to-date.
In a risk-on environment, small caps outpaced their large cap counterparts; the Russell 2000 Index gained 11.0% versus 8.0% for the Russell 1000 Index. Value stocks continued to outperform growth stocks, with a gain of 10.4% for the Russell 3000 Value Index versus 6.1% for the Russell 3000 Growth Index. Year-to-date, value extended its leadership over growth to 1,500 bps.
Developed non-U.S. equities followed a similar return pattern. The MSCI EAFE Index rose 5.4%, with energy (+12.3%) leading the way again and broad sector strength outside of real estate (–1.2%). Regionally, all European countries posted gains despite Russia escalating its aggression in Ukraine and ongoing economic uncertainty. Hong Kong (–12.2%) was the only market to suffer a material decline, a victim of the selloff in China.
Most real assets posted positive performance during the month, led by energy equities (+25.0%), which rallied on higher commodity prices and exceptionally strong third quarter profits. Crude prices (+8.9%) climbed higher after OPEC+ announced a supply cut of 2 million barrels per day as European sanctions on seaborne Russian crude approached and global demand remained resilient despite high prices. Natural gas prices in the U.S. were largely flat while European prices fell sharply (−36.7%) due to warmer weather and storage facilities filled to near capacity. Despite the decline, prices in Europe were still nearly 40% higher than pre-war levels; the energy crisis in Europe could intensify if a cold winter ensues.
MLPs (+12.0%), which own and operate energy infrastructure, also posted strong returns as U.S. volumes and energy exports increased. Energy infrastructure contracts typically contain inflation escalators, which—in addition to higher commodity volumes—can provide a strong tailwind to cash flows during periods of rising inflation.
After declining by 12.3% in September, global REITs finished October in positive territory (+3.0%), led by Europe (+4.6%), where concerns around energy shortages and recession eased. In the U.K., property stocks advanced 6.2% as a change in fiscal policy and prime ministers calmed markets. By sub-sector, leaders included hotels (+19.7%), which rallied sharply on continued strength in rates, occupancy, resilient leisure demand, and growing business and group bookings. The retail sector increased by 12.3% as fundamentals showed strength despite continued inflation and decreased consumer savings.
The September CPI report was released in October. On a year-over-year basis, headline and core inflation rose 8.2% and 6.6%, respectively. These numbers, along with other elevated measures of inflation, led to another 75 bps rate hike in early November. Markets reacted negatively and yields continued to shift upward over the course of October. Toward the end of the month, the yield curve experienced a brief inversion between the 3-month T-bill and 10-year T-note, which, along with the persistent inversion since July between the 2-year and 10-year Treasury yields, signaled the uncertainty of the economy’s path. As a result of these moves, longer-dated bonds experienced the worst performance with long U.S. Treasuries falling 5.5%. Intermediate Treasuries showed less impact of rising rates, falling a more modest 1.0%.
Rising yields also negatively impacted spread sectors, which led to declines in investment-grade corporates (–1.0%) and in securitized assets (–1.4%). In total, the broad fixed income market, as measured by the Bloomberg U.S. Aggregate Index, fell 1.3% in October and 15.7% YTD. The fixed income market is in the midst of its longest and most painful drawdown on record. Although current inflationary pressure is below the levels experienced in 1979–81, the sharp rise in interest rates from the zero lower bound has had a much larger impact than the drawdowns during the years Paul Volcker was Fed chair.
Within fixed income, the only areas of positive returns were in the below investment-grade universe. High yield bonds, which have a much larger spread cushion to absorb higher interest rates than their investment-grade counterparts, rose 2.6%. Similarly, leveraged loans, which benefit from higher coupon resets in a rising rate environment, gained 1.6%.