Knowledge Centre

Knowledge Centre Archive

Nov
14
2011

October 2011 Market Update

  • News of a eurozone deal and positive U.S. economic data releases were welcomed by investors, before the mood began to turn sour again towards the end of the month. 
  • Short-lived positive sentiment led October’s rebound in the global equity and bond markets. 
  • In a reversal of the summer’s fortunes, equity and riskier fixed income investments performed best.

Global equity and bond markets experienced a positive month. The markets witnessed a reversal of investor sentiment from preceding months and again began to invest in riskier assets. News of a eurozone deal to help tackle the mounting debt crisis and positive U.S. economic data releases helped to foster an optimistic mood. While market volatility had cooled for much of October, things began to turn sour as the month drew to a close, with the markets once again changing direction due to reports of rising borrowing costs in Italy.

Economic Backdrop

Market sentiment improved throughout October as investors were comforted by news that Europe’s leaders were working on a way to coordinate their efforts to support the eurozone and European banks. By the end of the month, an agreement aimed at preventing the Greek debt crisis from spreading to larger eurozone economies was announced and helped to further boost investor confidence. Although details were not finalised by month end, under the proposed deal, banks holding debt in the troubled country would accept a 50% loss on their returns and would be expected to raise more capital as protection against losses from other potential government defaults. As part of the same package, it was also announced that the European Financial Stability Facility (EFSF, the eurozone’s main bailout fund) would be boosted from €440 billion to approximately €1 trillion. The head of the EFSF also began attempts to persuade China and other international countries to invest in the rescue deal.

Upbeat economic news, particularly concerning the U.S., played a part in fostering October’s positive market returns. Stronger-than-expected economic data releases and upbeat corporate earnings reports eased fears that the U.S. was on the brink of another recession. U.S. gross domestic product readings for the third quarter of 2011 were reported at 2.5% and were in line with expectations. More importantly, growth was significantly higher than had been recorded for the second quarter, which tracked a 1.3% rise. Although still higher than hoped, U.S. unemployment levels shrunk in both September and October, and manufacturing output also exceeded expectations. However, despite the good news, consumer sentiment in the U.S. dropped in October, signalling that a degree of investor caution remained.

Market Impact

As volatility calmed, bond markets experienced a reversal. After falling out of favour during the risk adverse summer months, high-yield and emerging market debt led in October. High-yield debt is rated below investment grade and both are considered to be riskier. Corporate bonds (particularly Financials) also benefited from improved sentiment, and while still in positive territory, global government bonds brought up the rear. Consequently credit spreads (the difference in yields between government and non-government bonds) tightened during the period, as yields move inversely to prices. Within government bonds, demand for traditional “safe haven” issuers, such as the U.S., U.K. and Germany remained relatively steady, but declined for struggling eurozone nations. As s result, yields for Italian, Spanish and Greek government debt rose for the month.

Equity markets rebounded strongly in October and gains were witnessed almost across the board. Market volatility gradually decreased throughout the month as investor risk aversion waned. Globally, the return to positive market sentiment resulted in pro-cyclical sectors (which are sensitive to economic fluctuations and tend to do well when confidence is high and economic growth is anticipated) leading the rally. As a result, Energy, Materials and Financials all performed particularly well after lagging in recent months. More defensive sectors, such as Utilities and Healthcare, struggled in comparison. Reflecting increased investor risk appetite, emerging markets also outperformed developed for the month.

Index Data

  • The MSCI AC World Index, used to gauge global equity performance, gained ($) 10.71% in October. 
  • The Barclays Capital Global Aggregate Index, which represents global bond markets, gained ($) 1.33% over the month. 
  • The Chicago Board Options Exchange Volatility Index (VIX), a measure of implied volatility in the S&P 500 Index that is also known as the “fear index”, fell from 42.96 to 29.96 during the month. 
  • WTI Cushing crude oil prices, a key indicator of movements in the oil market, rose from $79.20 a barrel at the end of September to $93.19 by 31 October. 
  • The euro strengthened against most currencies in October, while the Japanese yen weakened. The U.S. dollar gained against the Japanese yen, but fell against the euro and sterling. The U.S. dollar ended the month at $1.61 against sterling, $1.39 versus the euro and at 77.978 yen.

Our View

Despite the uncertainty and the recent pain, we continue to favour stocks over bonds. Although the economic outlook has been downgraded by economists, in our opinion, the data still supports a positive view of overall business activity in the U.S., the European core economies (those with the largest economies) and developing markets. Equities are expected to benefit from continued earnings growth and exceptionally low valuations. We favour high-yield bonds over treasuries and investment-grade debt. High-yield bonds appear priced for a recession that we do not think will materialise. We remain neutral to emerging-market debt and equity. With regard to emerging-market equity, economic growth prospects remain an important positive factor, but we believe that valuations relative to developed markets are somewhat expensive.

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