The stock market enjoyed one of its largest monthly gains in history last month, with the S&P 500 Index rising 8.30 percent. After testing the August lows at the end of September, stocks rallied strongly in October, with sectors such as pharmaceuticals and biotechnology finally rebounding after a period of consolidation.
Economic data was so strong during October that the Federal Reserve dropped the sentence about overseas economic weakness as a potential threat to growth. GDP growth in the third quarter was 1.5 percent, according to the government’s first estimate. That is faster than the Atlanta Fed’s GDP Now model, which was forecasting only 1.1 percent growth ahead of the report. Economists had a consensus forecast of 1.8 percent and many are still looking for 2 percent or more. If incoming third quarter data improves over the next month, those estimates may yet be hit. The Atlanta Fed’s initial forecast for GDP growth in the fourth quarter is 2.5 percent.
As for the Federal Reserve’s interest rate policy, the omission of the statement about overseas weakness sent the odds of an interest rate hike sharply higher. Based on futures market contracts, speculators raised the odds of a December hike to 50 percent at the end of October. The odds of a January or March rate hike increased to 57 percent and 72 percent, respectively. Those numbers are all up about 10 percent to 15 percent from where they were prior to the Fed statement. As for the Fed itself, the language change signals a rate hike could come at any meeting, but it will take improved economic fundamentals to push the Fed over the edge.
The market’s reaction to the less dovish Fed statement demonstrates financials are set to rally once the Fed decides to hike. Fidelity Select Financials (FIDSX) gained 2.3 percent on the release of the Fed’s statement on October 28. Stocks initially tumbled on the news, but the financial sector held gains from earlier in the day and continued rising into the close. During the month, bank earnings were mixed, with large banks lagging a bit due to lower revenues from their trading divisions. Small banks that focus on lending to consumers and businesses were in better shape. The month ended with a buyout offer: regional bank KeyCorp is targeting smaller First Niagara, a positive sign for the industry.
Although stocks were rallying back from August’s losses in October, they also benefited from a strong earnings season. Analysts were forecasting a better than 5 percent drop in earnings for the S&P 500, with the energy sector responsible for most of the anticipated losses. Earnings beats from Exxon (XOM) and Chevron (CVX) helped curtail energy losses and the sector has delivered the biggest positive surprises, but the improvement in S&P 500 earnings growth mainly came from the healthcare and technology sectors. Healthcare has more than doubled its 6.2 percent earnings estimate midway through earnings season, while technology swung from a small loss to 3.2 percent growth.
In terms of stock market impact, earnings beats by Amazon (AMZN), Microsoft (MSFT) and Alphabet (GOOG) powered the Nasdaq. Shares of Amazon started October at about $500 a share and they closed at $625 per share, a gain of 25 percent. Google moved from $600 and change to more than $700 per share, while Microsoft rallied from the low $40s to low $50s. All benefited from the rise of high-margin cloud services. Telecom also rallied strongly and had the best earnings of all S&P 500 sectors, with growth of 22 percent, driven by strong results from AT&T (T). As a small sector in the index, however, the impact is limited
There were a couple of notable earnings misses during the month as well, though their impact was limited to their own firms. International Business Machines (IBM) missed revenue estimates and, later in the month, it announced the SEC was investigating the way it recognizes revenue. Shares slid to a new 52-week low in the wake of the latter revelation. Wal-Mart (WMT) disappointed investors and blamed higher wages, the result of its decision to hike wages earlier this year. The difference between Wal-Mart, a brick-and-mortar retailer that relies on human labor on the one hand, and the more virtual Amazon with its automated warehouses and cloud computing services, could not be starker. Amazon’s market capitalization eclipsed that of Wal-Mart’s back in the summer, but since then they have wildly diverged. Amazon’s market cap is now 60 percent higher: $293 billion versus $183 billion.
The Fed’s December meeting will loom over the coming weeks and the release of the October meeting’s minutes could swing interest rate expectations in either direction. China’s economic slowdown remains a concern, and the country will also gain attention as the International Monetary Fund plans to vote on whether to add the yuan to the special drawing rights (SDR) currency basket. The yuan is likely to depreciate due to economic weakness, but a strong bounce is possible if the IMF adds the yuan to the currency basket. With exports sliding, however, China doesn’t want to see too much currency strength. Since the yuan is still highly tied to the dollar, a rally in the greenback would be bad news for Chinese exporters.
The U.S. dollar is at an important juncture, only a few percentage points away from its 52-week high. A move higher would spark bullish buying that would likely spark a new bull rally. Small caps tend to outperform when the dollar is strong, and although they lagged in October, small caps outperformed strongly on days when the dollar rallied versus the euro. Oil prices will be key for commodity markets and high-yield debt, with higher oil prices better for both. Crude oil finished October still fighting around the $45 level. As long as black gold can hold above the low $40s, investors will maintain at least a neutral outlook on the sector.