What’s Driving October Volatility in the Stock Market?

October is here and historically we have seen negative performance across the broader markets. October 2018 started no differently with a huge decline across all the market. As of Fridays close all the markets where down off their high’s just over a week ago. Both the S&P500 and the DOW have shed 6% the last week. The NASDAQ down almost 8%, has not seen a similar decline since February.

The Tech Sector took the brunt of the selling, and it is no surprised considering the power houses making up the NASDAQ. May analysis considered the FANG stock way over valued. It was only a matter of time before these companies came tumbling back to a more appropriate valuation. Tech wasn’t alone, as the price of oil fell, a little more than 2 percent Wednesday Oct. 10th.

Driving Factors:

Inflation Fears

With inflation fears and rising interest rates, investors are spooked about what that means for the stock market. The Federal Reserve raised interest rates again which now sits at ~ 2.25 %. The rate is closely tied with credit cards and home equity loans. Climbing bond yields, increased labor costs, coupled with loftier borrowing expenses, have investors worried this will eat into corporate margins, and are hesitant about another potential increase in the Fed rate. During PPG earnings release, they noted, “These inflationary impacts increased during the quarter and, as a result, we experienced the highest level of cost inflation since the cycle began two years ago.” Higher costs will force higher costs around the industry, and may see other sectors like automotive affected. However, bullish investors may not see rising yields as a concern. JP Morgan saw increased profit and revenues due to increasing rates.

Rising Bond Yields

The US treasury market is seen as a large indicator of how the economy is doing. Recently the 10-year treasury yield eclipsed the 3.25 % mark which is contributing the investor worry. Higher rates will bring tighter financial conditions, hindering the corporate growth and profits. If yields continue to rise, we could continue to see further decline in the equity market. The concept is simple, if bonds yield a larger return than stocks, then stock prices will continue to retreat until they become more valuable then bonds again.

Investment Rotation

It doesn’t come at a surprise that there have been a few key companies driving the market rally. It is only natural for fund managers to begin selling the winners, and start looking at new areas of the market. Tech has cornered a lot of capital that has flowed into the market, and the transition away from Tech can be seen as a contributing factor to the sharp decline. We are starting to see a transition into more value stocks that will help buffer the volatility as we head into the final quarter of the year. Additionally, we have witnessed the end of the quarter is typically correlated with weaker performance. Coupled with rising bond yields, interest rate hike, and inflation fears all contribute to investors being spooked.

Technical Take

“We’ve had this rolling correction. It started with the small caps over the last couple of months and now, they’re getting to the mega caps. The correction sort of rolled and we’re finally getting to the big boys,” said Peter Boockvar, chief investment strategist at Bleakley Advisory Group.

As noted by the chart, the market does indicate we are in a period of correction. The selloff in the first week of October is not necessarily a cause for complete panic. The S&P is still up 2.5 % for the year. As we head into earning seasons, investors will need to be mindful of their expectations. Earnings may see damped numbers this quarter due to the trade war, China’s economic woes, and a myriad of other geo-political influencers. Analysts will be watching the charts expecting the market to trend back to the 50 day moving average. Thursday’s continued sell off saw the S&P500 hit its 200 day moving average. Last time the S&P hit the 200 SMA was back in February. If bond yields keep rising we are going to see more pressure on stock prices. It is early to call this a bear market but, analysts will be watching for the signs. Investors should prepare for continued pressure on equity prices.