October 2015 Recap

October is always a month of change. For those of us living in the Northern hemisphere, it’s when summer finally gives way to autumn. The colors change. The days get shorter and cooler. It becomes “football weather”. And for sports fans in the U.S., the final week of October is just about as good as it gets: the NFL and college football seasons are in full swing, the World Series is underway, and the NBA and NHL regular seasons are just starting up. The end of October also means Halloween is upon us and the holiday seasons of Thanksgiving and Christmas are right around the corner. For many, this is the beginning of the best stretch of the year. Interesting, Halloween is the second most expensive holiday, after Christmas. According to the National Retail Federation, Americans will spend about $6.9 billion on Halloween this year. That breaks down to $74.34 per person. Americans will spend $350 million alone on costumes ... for our pets! Amazing.


As far as the capital markets go, October can be especially interesting as well. The “October Effect” is a theory that the stock market is more volatile and subject to crashes in October. Proponents point to the market crashes of 1929 and 1987, and a very rough 2008. However, most statistical evidence doesn’t support the theory, but psychological expectations of the October Effect still exist. Just ask any trader. Well, “October Effect” proponents will have to shelve their theory for another year because October was a very positive month for the U.S. stock market and for most other stock markets around the world, and the gains came as market volatility actually went down during the month. However, the gains booked in October only brought the world’s stock markets to just slightly above breakeven for 2015 year-to-date, and the emerging market’s index is still down almost 10% for the year so far. So what drove the market gains in October? The simple answer is: more “easy money”. Global central banks kept stimulative policies intact, and many hinted at further easing measures to come – news that served as a tailwind for stocks and other risk assets for October, just as it has been for the markets for the last several years.

It’s worth going back and recounting, once again, how we’ve gotten to where we are. The financial crisis that began in 2007 and ushered in the Great Recession was unique. It caused central bankers around the world to work together in unprecedented ways as they intervened in the world’s economies and implemented never-before-attempted policies in an effort to abate the crisis, calm fears, and foster growth. In addition to simply keeping short-term rates low, major central banks instituted unconventional measures such as forward guidance and outright bond purchases, i.e. “Quantitative Easing” (“QE”). At the time, it was thought that the policies being put into action would be relatively short term in nature. The plan was that the measures would remain in place only until the world’s economies “got back on their feet” and economic growth returned to something close to “normal”. …. Well, that was more than six years ago, and not only do most of the accommodative policies remain, many of them have been extended and even expanded. Amazingly, for the amount of stimulus and accommodation that has been unleashed by central bankers, the global economy remains stuck at a sub-par growth level.

Another factor that will complicate things now is that central banks are beginning to diverge in terms of policy. While overall, the world’s central banks remain very accommodative, the U.S.’s Federal Reserve (“the Fed”) will soon join the very few other central banks that are beginning to remove accommodative policies and actually start tightening. For the U.S., the changes may occur as early as December. However, when the Fed begins raising short-term rates, the path of rate increases are expected to be very gradual and shallow.


In marked contrast to the U.S., China is faced with an economy decelerating more quickly than expected after years of rapid expansion, and policymakers there have been rapidly implementing stimulative policies to encourage growth. Just a few weeks ago, China’s central bank cut its benchmark lending rate by a quarter of a percentage point and reduced the amount of cash that Chinese banks are required to hold. The rate cut was China’s sixth since November 2014. Still, recent data shows that the nation’s GDP expanded at an annual rate of 6.9% in the third quarter of 2015, the nation’s slowest growth rate since the financial crisis.

Sometimes it’s wise to step back and consider the big picture. China, the world’s second-largest economy behind the U.S., has undergone massive changes in just a few decades. The Industrial Revolution in the U.S. occurred over 60-80 years. China’s industrial revolution has taken only three decades. The U.S. population at the end of its Industrial Revolution was around 17 million people. China is home to 1.4 billion people. That’s 82 times the number of people using technology that’s two hundred years’ more advanced, so it’s no wonder China vaulted to become one of the world’s largest economies, and greatest world powers, so quickly. However, such rapid growth comes with its own list of issues. China’s communist government is centralized, so all planning comes from the top down. This means they can plan everything out at a macro level, and the Chinese government is doing just that: restructuring the Chinese economy away from an investment spending model and towards a more domestic consumption-driven one. The plan to restructure is a wise one, but the transition won’t be smooth and will necessarily mean an intentional slowdown in growth. In fact, policymakers in China are targeting 6.5% GDP growth for the next five years, a growth rate much lower than what China is used to. The good news is the Chinese government still has ways to manage this slowdown, with ample reserves and monetary policy tools.

The implications of China’s slowdown are very important to the world’s economy. For other emerging markets, slower growth in China is a headwind via slower trade and lower commodity prices. However, for developed markets like the U.S. and most of Europe, which are predominantly commodity importing countries, the benefits could end up outweighing the negatives (or at least offset some of them).

In just the past few years, China passed Japan to take over the number two spot on the list of the world’s largest economies, and the two countries are on entirely different trajectories. China is experiencing a slowdown but is still growing at an above-trend level compared to the world as a whole. Japan is fighting to reinflate itself after decades of sub-par growth and deflation. Japan unleashed an enormous stimulus plan in an attempt to get itself growing again. Among other measures, it involved the Bank of Japan (BoJ), the nation’s central bank, purchasing hundreds of trillion yen (several trillion in USD) since 2007. Just last month, the BoJ passed on expanding its record stimulus even further, signaling a belief that the central bank’s inflation target of 2% is attainable despite troubling signs in the Japanese economy, including slowing exports growth, but their otherwise massive stimulus plan is still in place. As a percent of GDP, Japan’s stimulative measures dwarf what’s being done in the U.S. and in Europe.


The European Central Bank (ECB) embarked on its own stimulus plan in 2009, a combination of bond-buying and currency depreciating measures, along with most of the world’s other central banks. That plan was expanded in early 2015 when the ECB announced a plan to purchase a total of at least 1.1 trillion Euros by September 2016. There’s now talk that that plan may be extended yet again. While employment is slowly picking up in Europe, the continent can’t achieve significant growth momentum, struggles to combat a threat of deflation, and risks stalling out again.

Stimulative policies by the world’s central banks have been a boon to risk assets like stocks and real estate over the past several years. New announcements in recent months by central bankers of extended and expanded stimulus have fostered the same results – more, cheap money has encouraged more risk taking – the purchase of more risk assets. Only a few months ago, stock markets around the world had fallen into correction territory for the year, but have recently bounced back to surpass where they had been before the sell-off began. Third quarter earnings did little, if anything, to help stock prices in this most recent rally, as earnings disappointed overall. However, the weakness seen in the earnings data will likely turn out to be a one-time reflection of a stronger dollar, which hurts U.S. exports, and low energy prices, which hurt U.S. energy companies that comprise a large segment of the U.S. economy. Looking forward, earnings growth is expected to resume in 2016.

So what can we expect for stocks going forward? With U.S. stocks trading near their long-term averages (price/earnings ratio), investors are likely to see average returns over the coming years, all other things being equal. While it’s probable that the Fed will raise rates in the coming months, it’s likely that stock prices may fall initially, only to bounce back in the months that follow as investors digest the better economic data the Fed used to justify the rate increase in the first place. Remember, the Fed’s justification for raising rates will be their belief that the U.S. economy is healthy enough to grow with less intervention. But be ready for more volatility in the markets as well. Historically, volatility picks up when the Fed begins its move to normalize policy via raising rates.