October has been a terrible month for equity investors so far. The S&P 500 and Dow Jones Industrial Average fell into negative territory for the year after yesterday’s steep declines. The Nasdaq composite entered into a correction territory of ’more than 10% fall from the peak‘ but remained 2.9% higher year-to-date. What seemed to be profit taking in the beginning of the month started looking like panic selling with the volatility index ’VIX‘ more than doubled this month.
The selloff in U.S. equities seems shocking given the robust earnings season. One-third of S&P 500 companies have announced their Q3 results, showing 25.4% Y-o-Y growth. This is more than double the historical average, but still, it’s not helping the bulls fight back.
Investors do not seem to be taking their decisions based on the present numbers, but they’re looking into the future. The forecasts for next year’s earnings show they are expected to decelerate to half of this year’s rate, and analysts are likely to continue downgrading their expectations.
The Macro environment is not helping either. We have the Fed continuing to tighten monetary policy, Europe’s economy is clearly slowing down with yesterday’s composite flash PMI falling to a 25-month low, and lots of uncertainty in China, the U.K., and Italy. While the U.S. economy seems to be the only one firing on all cylinders, yesterday’s home sales data may indicate that we have reached the peak of the current economic cycle. New home sales in the U.S. fell to a two-year low in September as higher prices and mortgage rates began to hit demand. Last week also showed declines in new homebuilding permits while sales of existing homes fell to a near three-year low in September.
Given the current environment, it's hard to say when the drama in equity markets will be over. Investors are selling first and evaluating later. Currently, the risks remain to the downside as further selloffs will trigger margin calls leading to further drops.
In currency markets, the Yen is the best performing currency as demand for safety surged. Meanwhile, the Dollar declined slightly against the Euro and Sterling but remained at a near two-month high. The focus will shift to the European Central Bank’s monetary policy meeting scheduled for later today. The critical question ECB President Draghi needs to answer is how Italy’s political turbulence can be contained and whether the recent economic weakness in the EU will delay the tightening of monetary policy.