Tuesday, November 1, 2016

October Recap - Stocks Weaken to Kick Off Q4

Equity markets saw some deterioration over the final few weeks of October as US stocks slid back to the bottom of their post-Brexit range.  The S&P 500 finished the month down nearly 2% while the Russell 2000 really took a hit, down almost 5%.  This was a departure from recent history as October had been the best month for stocks over the last 20 years with the S&P returning more than 2% on average and finishing higher 70% of the time.

Much has been made of the weakness in small caps over the last month and rightfully so as they (and micro caps) were the biggest losers in October.  However if we take a longer-term view, we can gain some valuable perspective.  The ratio chart of the IWM vs SPY has been in a well defined channel since 2013.  It recently tested the top of this range and was due for a potential reversion.

Some other things of note that took place during the month:
  • 10 yr yields are up almost 20% from the September lows
    • Regarding yields -are secular lows in?  Nice positive divergence with room to run before a potential test of the upper boundary (long-term chart below).
  • Financials and Utilities were the only two positive S&P sector performers during the month.
  • The Dollar looks set to rally to the top of its 2 year range (chart below)

  • Real Estate and REITs down 7-8% for the month
  • Biotechs underperformed - down 8+%
  • Metals were very weak with miners down 10+%
Very generally, much of the sector performance can be attributed to the strength in yields as that is positive for financials but not so much for real estate.  Meanwhile, the dollar's strength has put pressure on metals.

Also, considering the strength in the dollar and the huge move in yields we would have expected to see relative weakness in large caps vs. small caps.  However, the S&P has held up remarkably well all things considered, leading us to believe that a December rate hike is already priced in.  Further, traders could be positioning more defensively ahead of the election by selling more risky small caps and rotating into large cap names.  Robert W. Baird & Co had some insightful commentary on these developments.

Recent action aside, there is a lot of seasonal data that suggests the last two months of the year should be strong.  We recently shared some stats on how favorable recent 4th quarters have been for stocks.
If this is to be, it might make sense for the market to sort've idle in place here until all of the election hysteria has passed.

Equally compelling though are the types of studies shared by Steve Deppe and others that remind us that the S&P still never really "broke out" after making new all-time highs in the summer.  In fact, if you really drill down into the numbers, Deppe shows us that the S&P reached an all-time high of 2,093 all the way back in December of 2014.  October 2016 finished with the S&P at 2,126, just 1.5% above the high made nearly two years ago.  Deppe has a point when he suggests that the S&P just needs to "prove it" at this point.

Ryan Worch is the Managing Director of Worch Capital LLC. Worch Capital LLC is the general partner of a long/short equity strategy that operates with a directional bias and while emphasizing capital preservation at all times.

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