Overall, October was a good month for equity markets. The US led the way with healthy returns in both US large and small company stocks. International markets were more mixed, with a strong dollar denting returns for US investors. Developed markets posted positive, but modest returns, lagging the US markets. Emerging markets continued their streak of disappointment by declining more than 3%.
The bond market was decidedly mixed, with rates rising modestly. However, returns on riskier bonds rose due to the spreads for riskier borrowers compressing relative to investment-grade peers and US treasuries. Capital markets are largely frozen, but spreads for high-yield borrowers do not appear to reflect an increased risk of distress. However, that may change, particularly in the loan market where rates reset faster and thus consume more of the cash flows from companies with greater levels of indebtedness. It seems reasonable to expect some kind of default cycle among those borrowers the more prolonged the current interest rate regime persists.
Inflation remains the topic of greatest concern to investors, as it drives Fed policy. As we write this, there are signs that inflation has begun to decelerate. Deceleration is different from prices falling, though some cyclical areas of the economy may see price declines. We expect the deceleration to continue, possibly with some fits and starts. However, the combination of base effects, prices starting at a higher level when compared to the prior year, and a slowdown of activity should help matters. How long it takes to get back to the Fed’s 2% inflation target, or if the economy gets there at all, remains an open question. We think what matters most to markets and the broader economy is that inflation is trending in the right direction and not accelerating further. It is also possible that the goalposts shift some as things stabilize.
In the market, it appears that animal spirits are tamer. In our view that is a good thing, as unbridled enthusiasm is the enemy of healthy prospective returns. As a reminder, we operate with a longer-term perspective. As we make decisions going forward, there are many nodes on the decision tree, but the probabilities for each node are imprecise and have a wide range. It is our opinion that many of those probabilities narrow with a longer time frame. We observe and keep in mind that over the short-term, prices tend to fluctuate more than fundamentals, particularly long-term fundamentals.
