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
In a week characterized by an absence of potential market-moving economic data, the S&P 500 Index dropped over 1% on concern over global growth, the likelihood of higher interest rates in the U.S. and a prolonged conflict in the Middle East. In the aftermath of the dovish Federal Reserve meeting, the favorable Scotland vote and the successful Alibaba IPO, investors’ moods turned pessimistic last week as worries surfaced about the global economy. There was no consensus among market observers as to what caused the market sell-off as the economic data was mixed and offered no real surprises. Coming off a week that saw the Dow Jones Industrial Average reach an all-time high, though, gave investors an opportune time to take some profits and reduce their overall equity exposure. While the second quarter GDP number for the U.S. was revised higher to 4.6%, it is the lack of growth in both Europe and Japan that is making investors nervous. Even China indicated that it would not boost its stimulus if economic data proves to be softer than expected. The European Central Bank’s governing council meets this week to discuss the weakness in Europe’s economy and further monetary easing measures may be implemented. By contrast, the next move on the part of the Fed will be to raise interest rates and some fear that the move may be sooner rather than later and be disruptive for the markets. The U.S. bombing of Islamic State targets in Syria and the belief that the conflict will be long and drawn-out only adds to the uneasiness among investors. Until now, the market has climbed a wall of worry and this climb is likely to continue as third quarter corporate earnings reports will be released in October, only adding to investor anxiety.
Sales of existing homes in August fell about 2%, the first drop in five months, while new home sales soared by 18% and hit the highest level in more than six years. Both pieces of data were encouraging signs for the inconsistent housing recovery. Durable goods orders plummeted by a record 18% in August after posting a record gain in July. The primary reason for the reversal was a huge decline in orders for commercial aircraft for Boeing. If the volatile transportation sector was excluded from the calculation, orders for durable goods actually rose modestly. Although jobless claims increased last week, the trend is near an 8-year low and suggests continued improvement in the labor market.
The bond market was jolted with news that Bill Gross, the widely recognized bond king who founded Pacific Investment Management in 1971, was leaving the firm to manage a new bond fund at Janus Capital Group. PIMCO had planned to fire Gross amid massive redemptions from his funds and the SEC was conducting an investigation into possible market price manipulation to boost returns.
For the week, the Dow Jones Industrial Average declined 1% to close at 17,113 while the S&P 500 Index lost 1.4% to close at 1,982. The Nasdaq Composite Index dropped 1.5% to close at 4,512.
The most important piece of economic data this week will come on Friday when the government releases the September employment data. The consensus estimate calls for 215,000 jobs to be created and for the unemployment rate to remain unchanged at 6.1%. The ADP payroll survey is also expected to show an increase of about 200,000 new jobs for September. Both the Chicago purchasing managers index (PMI) and the ISM manufacturing index should confirm that the manufacturing sector is expanding at a healthy rate.
Only a handful of familiar companies are due to report earnings this week, among them being Walgreen, McCormick Inc. and Constellation Brands. Third quarter earnings will begin in earnest the following week.
With the bull market approaching six years in length, the fourth longest in modern history, there has been some concern that the breadth of the market has been narrowing. In other words, fewer and fewer stocks in the S&P 500 Index are accounting for the advances while there are increasingly more stocks that are lagging with negative returns. Despite the index trading near an all-time high, the average return of all 500 stocks from their respective highs has been negative. This anomaly is due to the fact that the S&P 500 Index is a capitalization-weighted index and is influenced greatly by the largest stocks, which have significantly outperformed smaller stocks this year. These divergences can occur in both size (small, mid and large cap) and sector (think small cap biotech and social media stocks earlier in the year and energy stocks now) and are not uncommon. While these divergences don’t necessarily mean that the broad market will suffer a correction, previous corrections and bear markets have been preceded by a significant narrowing of leadership. Their predictive ability is not foolproof but investors should be aware that they are occurring.