Another October Surprise Isn't in the Cards for Investors This Year
My main argument for continued tranquillity in the markets: Interest rates are likely to remain low for the foreseeable future.
October has a larger-than-life reputation for financial savagery. The Panic of 1907, America’s worst-ever bank run, erupted in October. The Crash of 1929 also happened in October. So did 1987’s Black Monday, when the Dow Jones industrial average plummeted 23% in one day. In 2008, with banks and securities firms failing left and right, the Dow shed more than 500 points on four separate October days. That set the tone for the brutal bear market that persisted until March 2009. Although the subsequent bull market is now 7½ years old, some of us haven’t fully recovered yet, either financially or emotionally.
Wait, there’s more. The price of West Texas Intermediate crude traded for $100 a barrel at the start of October 2008. By month’s end, the oil benchmark stood at $68, evidence that when the economy is in big trouble, hard assets are no sure cure. And had the U.S. defaulted on its bond obligations in 2013 (the last time Congress played chicken with the debt ceiling), the Treasury would have missed its interest payments for the first time ever in October. You get the idea.
Now, you might think that this litany of misery is my way of warning that something horrible is going to occur this October, perhaps tied to the peculiarities of the presidential campaign. And with stocks and bonds looking expensive by most historical measures, the next bear market (in both stocks and bonds) could be severe. Income-oriented investors, who have benefited enormously in recent years from the torrid performance of such rate-sensitive sectors as utilities and real estate investment trusts, are particularly vulnerable.
More of the same. Yet despite questions about value, concerns about Brexit and the usual litany of risks, markets have remained remarkably placid so far in 2016. I believe this relative calm will extend into October and continue for the rest of the year.
The main reason for that continued tranquillity: Interest rates are likely to remain low for the forseeable future. (Investment guru James Paulsen disagrees; read our interview with him.) So far in 2016, the yield on the 10-year Treasury bond has swung between 1.35% and 2% (it stood at 1.5% in early August). Although the Federal Reserve may raise short-term interest rates once this year, the yield on the benchmark Treasury won’t zip past 2% anytime soon because the economy isn’t strong enough to support much higher rates. So bond yields are unlikely to rise to the point at which they start pulling money away from dividend-paying stocks, but they will remain high enough to encourage foreign investors and pension funds to keep buying dollar-denominated bonds and bond-like investments.
The gloom-and-doom crowd is left to bellow warnings about the dangers of “reaching for yield” and turn routine business and economic news into signs of impending disaster. Worried about slow economic growth? Yes, growth in U.S. gross domestic product has been lackluster (1.2% in the second quarter), but look at the strength in job creation, family incomes, and the housing and manufacturing sectors. Concerned about corporate profits? Yes, the second quarter marked the fourth consecutive quarter of year-over-year declines in earnings. But a less-robust dollar and the end of oil’s freefall should result in better numbers for the rest of 2016 and 2017. Terrorism? Even the Europeans, who have suffered a lot lately, recognize that the financial markets don’t move in lockstep with current events.
A black swan—an utterly unpredictable catastrophe on the order of 9/11 or the mass bank failures of 2008—can always materialize, leading to severe market losses. But don’t enter the final stretch of 2016, a year that has delivered surprisingly solid gains in both the stock and bond markets, worrying that your returns are a fluke and respond by shredding your investment plan.