Key Points:
- The Federal Reserve is expected to raise the Fed Funds rate an additional 75 basis points in November to contain high prices.
- Stocks rallied strong in October with the Dow having its highest monthly return in decades.
- Higher yields in bonds have caused bond prices to fall but investors are finally getting attractive yields in short-term assets.
The Federal Reserve is primed to raise its benchmark rate another 75 basis points this week in their conquest to slow down economic activity and bring down inflation. This will be the fourth consecutive increase of that size as inflation remains stubbornly high. Despite higher rates, the US economy advanced 2.6% in the third quarter after two quarters of economic detraction. The main components driving growth were increases in exports (mostly energy) and consumer spending. Higher interest rates are being felt in the housing market as sales of new homes fell 10.9% in September as surging mortgage rates are giving would-be buyers pause. US mortgage rates topped 7% for the first time since 2002 and will likely cause prices of existing homes to fall. This drop in prices will take time to show up in inflation calculations making the Fed’s job more challenging.
Stocks rallied in October on the hopes that the Fed may be closer to slowing rate increases. The Dow Jones Industrial Average posted its best month in decades, gaining 14.07%. The more diversified S&P 500 advanced 8.1% while the tech-heavy NASDAQ gained just 3.94%. Value stocks were the best performers during the month with strong gains in energy (+24.96%), industrials (+13.92%) and financials (+11.99%). Earnings (which ultimately drive stock prices) have come in rather strong this quarter. Through the end of October nearly 71% of the 263 companies that have released third quarter results have beaten their expectations according to Guggenheim Investments. Small cap stocks had a solid month with the Russell 2000 gaining 11.01%. International stocks were mostly flat for October as high inflation in Europe and a selloff in Chinese equities had global investors seeking solace in US dollar assets.
Higher interest rates continue to weigh on the bond market with the Bloomberg Aggregate bond index falling 1.3% in October. Two-year Treasury yields topped 4.6% during the month after yielding below 0.5% just a year ago. While this has been one of the most challenging environments to be a bond investor, it has been years since yields have looked this attractive. Strong corporate balance sheets should provide stability to high quality bond investors if we experience a recession over the next year. High yield bonds held up well during the month (+2.68%) but it may be a bit early in the economic cycle to take on excessive risk in the bond market. In the meantime, investors are finally earning something on short-term bond investments.
Sources: Morningstar Direct, JPMorgan, First Trust, Wall Street Journal