October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February. – Mark Twain
The month of October has historically been one of the most volatile months of the year and this past week lived up to this reputation. After plunging mid-week with a loss of 3%, the S&P 500 rallied on Thursday and Friday to end the week with only a modest loss. The Nasdaq Composite Index actually bucked the trend and wound up with a small gain, which broke a two-week losing streak. The roller coaster ride began on Tuesday when the ISM manufacturing index for September fell to its lowest level since 2009. It was the second consecutive month that it recorded a reading below 50, levels that indicate contraction, which sounded alarm bells among investors that the manufacturing sector was slowing faster than anticipated. Even though manufacturing represents only about 10% of the U.S. economy compared to about 90% for services, the report was a worrisome sign. In two days, the Dow Jones Industrial Average plunged over 800 points as investors feared that a recession might be just around the corner. On Friday, though, the September employment report showed that 136,000 new jobs were created and that the unemployment rate fell to only 3.5%, the lowest level in 50 years. While the number of jobs created was about 10,000 less than expected, July and August were revised higher for a net gain of 45,000 jobs. Although wage growth was flat and only 2.9% higher than it was a year ago, the lowest unemployment rate since 1969 is what economists will remember about the report years from now. In many ways, it was a Goldilocks report, not too cold as to spark renewed recession fears and not too hot as to think the Federal Reserve is done cutting interest rates. It was also a week when the stock market did not rise and fall on the latest developments in the U.S.-China trade war. That will change this week, though, as talks between the two countries resume on Thursday and markets will be looking for any sign of progress.
The ISM non-manufacturing or services sector index was also weaker than expected in September but managed to stay above the 50 threshold, which indicates expansion. Construction spending was also less than forecast in August but falling interest rates may lead to a pickup in spending. In other jobs reports, ADP reported that 135,000 private sector jobs were created in September, which was less than expected, and weekly jobless claims rose by 4,000 to 219,000, slightly higher than expected but still indicative of a strong labor market.
The U.S. and China aren’t the only two countries fighting a trade war. The U.S. imposed $7.5 billion in tariffs on European Union airplanes, French wines and Italian cheeses in response to illegal subsidies that aerospace firm Airbus received from the European Union. The EU plans to retaliate.
For the week, the Dow Jones Industrial Average dropped 0.9% to close at 26,573 and the S&P 500 Index declined 0.3% to close at 2,952. The Nasdaq Composite Index rose 0.5% to close at 7,982.
The September producer price index (PPI) and the consumer price index (CPI) are both expected to edge up just slightly while the preliminary October consumer sentiment index is expected to be slightly lower than it was in September. The Federal Open Market Committee (FOMC) also releases minutes from its meeting in September.
The only notable quarterly earnings report scheduled to be released this week is from Delta Airlines.
Through the first nine months of the year, stocks and bonds have delivered above-average returns that have resulted in strong overall performance in client portfolios. The S&P 500 Index of large cap stocks has produced a total return of 21.5% as growth stocks (up about 23%) continue to outperform value stocks (up about 18%). The gap between the two styles closed significantly in September as value stocks that have lower valuations and higher dividend yields were favored by investors. Among individual sectors within the S&P 500, technology, utilities and consumer staples have been the three best-performing sectors while energy, health care and materials have been the worst. For the most part, mid-cap stocks (up about 23%) have outperformed large cap stocks while small cap stocks (up about 14%) have underperformed. Returns for international equities continued to trail domestic equity returns due largely to a stronger dollar and weaker growth overseas. Developed international stocks were up about 12% through September 30th while emerging market stocks posted returns in the mid-single digit range. The best-performing asset class has been real estate investment trusts or REITs with returns approximating 28%. REITs have benefited from declining interest rates as well as from investors’ desire for higher yields and more defensive sectors. Fixed income investments have also produced strong returns this year as short-term bonds are up about 5% while intermediate-term bonds are up about 10%. Bonds have been the beneficiaries of falling interest rates and a dovish Federal Reserve. Even gold, which has been a dismal performer for a long time, came to life and has risen about 15% this year. Much of the market strength has been due to optimism over an eventual trade deal along with an accommodative Federal Reserve, both of which should lead to stronger profit growth in the future.