Nervous Investors Confront Earnings, China, the Election and the Fed

Stocks lost ground last week as concerns about the direction of monetary policy, corporate earnings, the Chinese economy and other issues weighed on the markets.

Minutes from the Federal Reserve Board’s meeting in September released last week showed that the decision to hold rates steady at that meeting was a close call. Several Fed committee members said they saw rates rising “relatively soon”—a statement many investors interpreted as evidence that the Fed may raise rates at its December meeting.

Meanwhile, earnings season for the third quarter got off to a rough start. Alcoa, a major aluminum producer and part of the Dow Jones Industrial Average, reported disappointing revenues and profits, citing a slowdown in its aerospace business. The firm did upgrade its expectations for automotive production in China, however. Telecom firm Ericsson reported reduced spending by its customers and worse-than-expected results for the quarter. And Samsung cut its profit expectations due to the much-publicized cancellation of its new Note 7 phone.

One bright spot was the transportation sector: Delta Airlines reported better-than-expected earnings, while railroad operator CSX beat revenue and earnings expectations.

Investors also appeared to be spooked by news that Chinese exports in September fell much more than expected, despite favorable moves in China’s exchange rate that was expected to boost competitiveness. Chinese holidays may have had something to do with this result, but the development bears watching going forward.

Oil rose to a one-year high early in the week after Russian president Vladimir Putin said Russia was ready to freeze, or even cut, oil output. Investors believe that such a move would help prop up oil prices, which have remained well below their all-time highs.

GAIN: Active Asset Allocation

Global equities struggled last week due in part to continued strength in the U.S. dollar relative to other currencies—a trend that’s being driven by rising expectations of a Fed interest rate hike by the end of the year. The dollar’s strength put pressure on international equities. We expected these scenarios, and therefore had reduced our international exposure going into the week.

Equities also faced headwinds from the growing prospect of a Democratic Party sweep of the Presidency and of Congress that would result in a united, rather than a divided, government. This outcome was viewed as exceedingly unlikely until the past week or so. Typically, investors prefer political power to be distributed among the parties rather than be controlled by just one group.

Fixed-income markets were relatively subdued, although corporate bond ETFs did underperform both their underlying bond holdings and credit default swap spreads. Increasingly, the fixed-income ETF space is becoming the price discovery mechanism for credit markets. This makes it very important to understand the dynamics around what is driving fixed-income performance, which we are well positioned to do.

PROTECT: Risk Assist

With global equity markets experiencing volatility last week, measures of expected future volatility started to increase: The CBOE Volatility Index (VIX) rose from 13 to 17, while the CBOE Emerging Markets ETF Volatility Index rose from 22 to 25.  

We have already positioned the Risk Assist portfolios for slightly higher volatility and do not plan on making any changes to these positions in the coming days. It’s important to note that, while last week may have felt more volatile, global equity markets are off just 2.7% from their 2016 highs.

SPEND: Real Spend

While global equity markets have had a rough start since the beginning of the fourth quarter, fixed-income markets have been relatively stable (as is often the case during down markets for stocks).

As the Presidential election approaches, and volatility likely increases around it, it is important to note that the Real Spend portfolios are constructed using a “barbell” approach—with relatively stable and resilient fixed-income holdings (including a spending reserve) on one side, and more volatile, growth-oriented equity holdings on the other. While the equity holdings can be expected to fluctuate, the spending reserve aims both to help buffer the portfolios from such fluctuations and to serve as a source of liquidity for current spending needs.