Presidential Election, Rate-Hike Odds Spook Markets in October

nyse FBN

The first month of the fourth quarter has historically been positive for U.S. equity markets as it leads off a robust period for Wall Street. During the fourth quarter, the S&P 500 has gained an average of 4% since 1945, according to data from CFRA’s Sam Stovall.

But 2016 has proved to be an exception to that rule as all three major equity indices closed the month in negative territory. The Dow Jones Industrial Average fared the best of the three, shedding 0.9% to 18142 . The broader S&P 500, meanwhile, lost 1.9%, falling to 2126, while the tech-heavy Nasdaq Composite erased 2.31% to 5189.

This month saw the Dow log its third-straight monthly loss, the longest losing streak for the index in five years since a five-month stretch of losses that ended in September 2011. October also marked the S&P’s third-straight down month, while the Nasdaq snapped a three-month win streak.

Sectors leading the markets lower were telecommunications, health care and real estate, while utilities and financials were the only two of 11 sectors in the green for the month.

Health care’s more than 6.5% drop was likely due in large part to the copious chatter on the 2016 campaign trail, according to iSectors Chief Investment Officer Chuck Self. Both candidates – Democrat Hillary Clinton and Republican Donald Trump – have discussed various health care reform proposals. For the better part of a year, Clinton has talked about ensuring drug prices don’t skyrocket for consumers – that in light of major increases from pharmaceutical companies like Mylan (NASDAQ:MYL), which came under fire in recent months for a surge in the price of its life-saving EpiPen. Meanwhile, her opponent has discussed repealing and replacing President Obama’s Affordable Care Act, more commonly known as Obamacare.

Financials saw a nearly 2.5% jump during October as markets ratcheted up expectations for an interest-rate increase from the Federal Reserve in December – a year after the U.S. central bank raised rates for the first time since the financial crisis. Federal funds futures, a tool used to predict market expectations for changes in monetary policy, showed odds for a rate rise at the final 2016 policy meeting at 77.7%.

“With rates going up, banks will be able to make more money. Financial earnings reports were also very good [in the third quarter]. Investment banks, retail banks, insurance corporations – they all had good earnings and that’s helped the sector,” Self said.

Meanwhile, the search for yield continued on Wall Street amid the ultra-low rate environment in October. Traders also bid up the utilities sector, which gained nearly 1% during the period. While Self called the move “odd,” he said it was really a continuation of a trend the markets have seen all year: Traders diving into stocks that yield more than traditionally safe government debt. While the yield on the 10-year U.S. Treasury bond sat at 1.83% on Monday, it was sharply higher than where it started the month, yielding around 1.6%.

The move higher in Treasury yields suggests markets are getting more confident about a December rate rise from the Fed, said David Joy, chief market strategist at Ameriprise Financial.

“All of that is reinforced by stronger economic data in the U.S. A majority of major economic reports have been pretty good and show a bit of a rebound from mid-summer and the third-quarter slowdown. It was capped by a good third-quarter GDP number of Friday.”

While the better data provide good fundamentals for the market, Joy warned the improving economic situation could also create headwinds for stocks which may see downward pressure in the wake of higher interest rates. He also said the strong dollar, up 3% against a basket of global currencies for October, is something to watch over the next several months. The greenback could continue to gain momentum should a perfect storm of higher rates from the Fed and more quantitative easing from the European Central Bank emerge in the final two months of the year.

“That’s a headwind for U.S. equities and that needs to be monitored carefully. If the dollar levels off from where it is, I think we’re fine, but the differential in overnight rates could come into starker contrast toward the end of the year,” he explained.