October has historically been one of the most volatile months for the stock market, and this year didn’t disappoint. It was 20 years ago on Black Monday that the Dow Jones Industrials fell 508 points; this year the Dow only fell 366 points. Back in 1987, investors lost 22%. Luckily in 2007 the 366 point drop only meant a 2.6% hit to investors’ portfolios. Despite the increased volatility, most equity and fixed income markets concluded the month in positive territory following the Federal Reserve’s decision to cut its target for the federal funds rate by 25 basis points to 4.5%. In addition, the central bank reduced the discount rate by a similar amount, to 5.0%. Money center banks followed with a reduction in the prime lending rate to 7.5%. This accommodating decision by the Fed was anticipated by many investors; however, the decision to cut interest rates was not an easy one. A decision either way by the Fed carries risks. Too large of a cut could result in inflation (rising prices for raw materials and imports due to a weak U.S. dollar), and the lack of a cut could push the slowing economy towards a recession. This conundrum, along with the Fed’s own statements, has led many to believe that the Fed will be more reluctant to ease credit further, creating more market uncertainly. Additionally, with the continuing effects of the subprime meltdown and further weakening in the housing market, another month of heightened volatility would appear likely.
For the month of October, the S&P 1500, a broad measure of the U.S. equity markets, returned 1.68%, with large cap stocks gaining 1.59% and small cap stocks gaining 1.86%. At the sector level, information technology (+6.57 %), utilities (+6.36%) and materials (+3.85%) stocks led the markets, while financials (-2.1%) and telecommunications services (-1.35%) stocks were the leading detractors during the month. Growth stocks continued to outperform value stocks across the broad market.
International markets were also positive for the month. The MSCI EAFE Index gained 2.41% in local currency terms, and was up 3.93% in dollar terms. Growth stocks outperformed value stocks. Among developed markets, Spain (+11.58%), Portugal (+10.94%) and the United Kingdom (+6.02%) posted the most significant gains during the month, while Sweden (-2.43%), Netherlands (+1.91%) and Switzerland (+1.92%) underperformed. The MSCI EAFE Small Cap Index gained 6.23%, while emerging markets continued their impressive gains advancing 11.15%. The BRIC Index gained 15.11%.
The fixed income markets were also generally positive for the month. The 10-year Treasury ended at 4.48%, down 11 basis points from the prior month, and the 30-year Treasury yielded 4.74% at month end, down nine basis points. The Lehman Aggregate Bond Index gained 0.90%. Government bonds increased 0.73%, while corporate bonds gained 1.17%. Mortgage backed bonds rose 1.01%, and municipals gained 0.45%. Other sectors increasing for the month included high yield bonds (+0.60%), international government bonds (+2.07%), and TIPS (+1.12%).
Commodities ended on the month on a positive note, with the Dow Jones-AIG Commodity Index gaining 3.33%. Real estate, as represented by the S&P REIT Index, rose 0.87%.