From a global tremor in sovereign bonds to a spike in energy costs, October lived up to its reputation as one of the most volatile months for markets. To stock bears’ chagrin, though, the tumult did nothing to halt the relentless rally in equities.
Not even disappointing results from two of the world’s biggest companies could slow the S&P 500’s push higher. It ended the week at a record despite declines in Apple Inc. and Amazon.com Inc., rolling up a gain of almost 7% for the month to notch the best October in six years.
Some credit for the market resilience goes to an earnings season that, outside of a few hiccups, has delivered an almost-unprecedented rate of positive surprises. Yet much of the latest rally comes down to the return of animal spirits. Take the options market, where traders piled into bullish calls to juice rallies in stocks like Tesla Inc. Inflows into equity funds also climbed to a seven-month high, as a majority of bears were forced to convert to buyers.
Momentum begets momentum. That can be especially true in the final two months of the year, when money managers get a last chance to make up ground before their annual report card is set. About three-fifths of the group trail their benchmarks, so an increase in risk-taking could add further fuel to a rally that has pushed the S&P 500 up more than 22% in the first 10 months.
“History, risk appetite and earnings all point to a ‘melt-up’ into year-end,” said Chris Harvey, head of equity strategy at Wells Fargo & Co. He expects the S&P 500 to finish December at 4,825, a 4.8% increase from Friday’s close of 4,605. “We believe it is too early to leave the party.”
The S&P 500 rose 1.3% in the five days for a fourth straight weekly gain, the longest streak since April. It has climbed in all but two of the past 13 sessions. The Dow Jones Industrial Average and the Russell 2000 each rose at least 0.3% in the period. The tech-heavy Nasdaq 100 outperformed, climbing 3.2% amid robust earnings at firms like Microsoft Corp. and Alphabet Inc.
While nothing spectacular, the weekly performance was impressive considering the threats lingering over the market. U.S. economic growth weakened more than expected in the third quarter and commodity inflation kept flaring. As central banks in the U.K. and Canada turned hawkish, the sovereign-debt yield curve collapsed around the world, a bond-market signal that growth will slow as short-term rates move higher.
Buttressing equities were earnings that have continue to defy the doom and gloom around supply-chain crunches and soaring input prices. While Apple warned bottlenecks threaten its holiday sales, companies such as Mattel Inc. are finding ways to get their products to consumers. And while Amazon warned that massive costs as a result of labor shortages could wipe out its profit in the final quarter of the year, others like Chipotle Mexican Grill Inc. are resorting to automation to boost productivity -- and earnings.
Broadly, more than 80% of S&P 500 companies have beaten analysts’ earnings estimates during this season, a pace never seen before the pandemic. Rather than shrinking -- as many had feared -- profit margins kept expanding.
The commentary from company management “has been all to the positive about how they have been passing through their input costs to the consumer in terms of raising prices, or using technology very efficiently to try to maintain their operating leverage,” David Kostin, chief U.S. equity strategist at Goldman Sachs Group Inc., told Alix Steel on Bloomberg TV. “The market does not wait for the problems to resolve themselves before focusing on the future.”
Investors started to flock to stocks after backing away in September. They pulled roughly $25 billion into equity exchange-traded funds this week through Thursday, the largest inflows since March, data compiled by Bloomberg show.
Traders hoping to make quick profits rushed to bullish options. Based on its 10-day average, a Cboe put-to-call ratio that tracks the volume of options tied to everything from single stocks to indexes fell to a three-month low.
From stock pickers to computer-driven traders, the urge to jump back into stocks was so strong after September’s rout that a Deutsche Bank AG measure of investor positioning jumped to the 87th percentile of a historic range from the 56th percentile in a matter of weeks.
Even traders who identify as bears have been buying. According to a survey by the National Association of Active Investment Managers, in the current distribution of sentiment, a bear is someone who is 65% invested in stocks. Such optimism only showed up twice in the survey’s history, at the start of this year and in the final months of 2017.
Complacency? Perhaps, especially next to the angst that bond investors are showing. The divergence can be seen in the ratio of the Cboe volatility index, or a measure of options cost known as VIX, and the MOVE Index, which tracks implied volatility in Treasury options. That ratio sank this month to the highest level since February 2020.
“The bond market is saying the Fed is behind the curve, there’s a policy accident ahead, and they’re going so far as to say that ultimately this is going to be a much shorter cycle at a lower terminal value to rates,” Lisa Shalett, chief investment officer of Morgan Stanley Wealth Management, told Lisa Abramowicz on Bloomberg TV. “That’s a pretty harsh statement that the bond market is sending, and the equity market thus far has shrugged it off.”
But the favorable seasonal pattern is hard to fight. Since 1927, the S&P 500 has notched gains in the final two months about 57% of the time. When the first 10 months saw the index rising more than 20%, as is the case in 2021, the odds of positive returns jumped to 75%.
The backdrop offers the window to chase performance into the year-end as a majority of active funds are trailing the market. Only 38% of mutual funds have beaten the S&P 500 this year, data compiled by Wolfe Research show. Meanwhile, an index tracking hedge-fund returns is up 11%, half the benchmark’s gain.
“An extension of the rally makes sense,” said Ross Mayfield, an investment strategy analyst at Baird. “I don’t know that it’s going to be anything too insane, but you have a kind of a seasonal tailwind.”
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