EQUITY & FIXED INCOME MARKETS
Equity markets favored large caps in October, with the S&P 500 Large-Cap Index, the S&P 400 Mid-Cap Index and the S&P 600 Small-Cap Index returning 2.3%, -0.5% and -0.9%, respectively. The Goodman Blended Equity benchmark rose 0.9% for the month. International stock indices were positive as developed markets ex U.S. were up 1.1%. Fixed income markets were positive in October as the Fed continued its current easing cycle. GFC’s Fixed Income benchmark was up 0.4% for the month.
DIVERGENT VIEWS
Equity markets and economic indicators continue to tell two widely divergent stories. On one hand, equity market performance in October has been driven by a surge of capital expenditures by the mega-cap technology names tied to Artificial Intelligence (AI). In fact, AI leader Nvidia just became the first company in history to cross $5 trillion in market capitalization. Of the eleven sectors that comprise the S&P 500, Nvidia itself is now larger than six of them. On the other hand, there are enough negative economic data points that would usually force the market to take a breather. For example, consumer sentiment does not appear to be strong, especially in the middle- and low-income segments, inflation remains sticky, labor markets are notably weaker, and very little GDP growth is found outside of AI.
This divergence was also evident in the Federal Reserve rate cut decision last week: Governor Stephen Miran wanted a half-point rate cut while Kansas City Fed President Jeffrey Schmid voted to hold rates steady. This was the first time since 2019 that there were opposing dissents at the Fed i.e. one member wanting to ease policy while the other wanting to tighten it by holding rates steady. Chairman Powell also commented that a December cut is not a foregone conclusion, noting inflation and labor market indicators remain in tension. As a result, markets are now pricing in a 62% chance of a December cut, down from 90% before this Fed meeting. The ongoing government shutdown (now the 2nd longest in history) may force a pause from the Fed due to a lack of reliable data. For example, the widely followed jobs data from the Bureau of Labor Statistics has been delayed indefinitely. “What do you do if you’re driving in a fog?” Powell asked during his press conference. “You slow down.”
The markets reacted positively to President Trump and China President Xi’s in-person meeting this month. The meeting ended with China postponing more stringent export controls on rare earths for one year, the U.S. lowering tariffs on Chinese goods, and China agreeing to buy U.S. soybeans and other farm products. Notably, Nvidia’s AI chips were not part of the discussions. We remain skeptical about this being a lasting truce given that punitive measures were just suspended rather than scrapped, while key issues (Taiwan, trade, and technology competition) remain unresolved.
Fixed income markets remain stable. While there is more of a question mark around the December rate cut now, short-term rates may continue to slightly fall given the Fed’s current easing cycle. Longer-term rates may rise given the dynamics around the government shutdown (now the 2nd longest in history) and the overall U.S. fiscal situation. There has been recent good news in housing markets: mortgage rates continue to trend down, and existing home sales recently hit a seven-month high.
But another indication of divergence is the early signs of stress in the private credit market, where a significant amount of capital has moved to in recent years to chase higher yields. As evidenced by recent loan losses among some regional banks, there may be more distressed loans uncovered during this earnings season. After the bankruptcy of sub-prime auto lender Tricolor Holdings last month, J.P. Morgan wrote down $170 million and Fifth Third Bancorp wrote down as much as $200 million in bad loans. After auto parts supplier First Brands filed for bankruptcy last month, multiple banks disclosed their exposure including Jeffries ($45 million) and UBS ($500 million estimate).
While this bears close monitoring, we are not seeing a large rise in defaults or widening high-yield credit spreads so far. Credit spreads are the difference in yield between corporate bonds and Treasury bonds that have comparable maturities. The broader question is whether investors are being adequately compensated for the higher-than-expected risk evident in this space over the past month. The attached chart from Charles Schwab shows that high-yield credit spreads are at multi-year lows. If there is a negative market surprise before year-end, we believe it may come from the private credit segment of fixed income markets and not necessarily from the equity markets.
Robin Kollannur, CFA
Chief Investment Officer
