October wasn’t easy for investors. They had to navigate to an earnings season, a market sell-off, ongoing trade wars and looming midterm elections. The result wasn’t necessarily pretty.

Global equities suffered their worst month since May 2012, and nearly $8 trillion of market capitalization was erased. The S&P 500® Index recorded losses in 16 of 23 trading days, and it almost fell into the second technical correction on the year.

Investors slogged through an earnings season hounded by worries that after three straight quarters of 20%-plus earnings growth, US growth has reached its peak and is being driven primarily by fleeting fiscal stimulus. It didn’t help matters that tariffs were mentioned by executives from roughly 70 firms on earnings calls this quarter, with a third of them pointing out negative impacts. Concern among investors that the Trump administration’s trade war with China will curtail growth and damage corporate confidence is growing.

This all took place as a contentious midterm election loomed, and eventually delivered a split Congress that could result in heightened DC gridlock.

The following four charts from our monthly Chart Pack show how investors reacted to October’s unsettling market environment and where they sought solace in defensive positioning.

Chart #1: The market sell-off was swift but not broad

Market sell-offs are alarming, so it’s helpful to put them into context. While October’s sell-off was worrisome, the orange line in the chart below shows that only about 18% of S&P 500 Index constituents hit 52-week lows. This compares quite favorably with recent market sell-offs, where roughly 30% of S&P 500 stocks that have hit 52-week lows. For example, in August of 2015, when the market sold off after China devalued the renminbi, more than 40% of S&P 500 firms touched 52-week lows. 

My take: October’s sell-off almost marked the second 10% market correction of 2018. But it wasn't broad-based, and fundamentals continue to underpin the stock market. Despite worries that US earnings growth has peaked, they still remain positive as does US economic growth. Although monetary policy is tightening, it is still accommodative relative to history. These fundamentals should continue to backstop future market sell-offs in the near term.

Chart #2: Wary investors favor defensive over cyclical factors

Amid the market sell-off, investors sought defensive exposures. The chart below captures the significant performance spike of defensive, bond-proxy exposures like minimum volatility equities and yield-oriented equities. Both factors outperformed the broad market by 3% in October. Minimum volatility is now the best performing factor in the US in 2018, outpacing momentum, which had been a darling since the summer of 2017.

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Source: Bloomberg Finance, L.P., as of 10/31/2018. Past performance is not a guarantee of future results. MSCI USA Minimum Volatility Index, MSCI USA Enhanced Value Index, MSCI USA Quality Index, MSCI USA Equal Weighted Index, MSCI USA High Dividend Yield Index, and MSCI USA Momentum Index were used above compared to the MSCI USA Index. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. 

My take: Momentum tumbled by nearly 10% during the technology-led October sell-off, losing its leadership position, and quality emerged as the best performing factor on a trailing 12-month basis. As we enter this late-cycle environment, we can expect to see firms with reliable cash flows and stable balance sheets be rewarded in the marketplace, two traits of firms commonly found in the quality factor exposure. 

Chart #3: Sector trends also skew defensive 

Investors’ defensive positioning was also evident at the sector level, with an uptick in performance among consumer staples and utilities. Health care has also been steadily outperforming the broader market. Firms in the health care sector typically have more reliable cash flows and stable balance sheets than the broader market, meaning investors often view them as a defensive, growth-oriented market segment.

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Source: FactSet. As of 10/31/2018. Past performance is not a guarantee of future results.

My take: This defensive factor positioning—which weighs on cyclical sectors like consumer staples and technology—is typical in a market concerned about peak earnings growth and heightened trade tensions. Interestingly enough, the performance of the health care line in the chart above has a similar pattern to the quality factor relative market performance in chart number two. This is one trend we will keep a close eye on as we head into 2019.

Chart #4: Fixed income focuses on short duration

This final chart illustrates how different segments of the fixed income markets have performed since the start of 2017. The bars represent each segment’s yield and duration, while the overlaid scatter chart shows the maximum drawdown witnessed from the beginning of last year through the end of June. The chart illustrates that floating rate notes experienced almost no drawdowns in this period while offering an attractive yield per unit of duration, but longer duration instruments endured more severe drawdowns while offering riskier fundamental profiles. 

My take: The performance of floating rate notes vs. longer duration instruments highlights the dilemma facing investors in today’s low yield environment where duration is elevated but yields remain low by historical standards—resulting in an increasingly unattractive risk/return profile. In such an environment, investors may want to look beyond the traditional sectors in the Bloomberg Barclays U.S. Aggregate Bond Index (the Agg) or consider using an active manager to augment traditional bond exposure. 

For instance, with the Federal Reserve expected to raise interest rates in December and two more times in 2019, floating rate exposure could help to mitigate duration-induced price declines while still potentially providing income. Senior loans offer another means of adding defense to a fixed income portfolio. These speculative grade credits with floating rate coupons are typically senior in the capital structure to fixed rate high yield debt and offer income while potentially also limiting drawdowns.

Weathering risks with a defensive tilt

While markets endured a sell-off in October, that type of market behavior is not uncommon for months or periods in which midterm elections are held. On average, in the years when there is a midterm election, the market usually falls 19%. However, data going back to 1962 shows that the market rebounds and has actually been higher one year later by an average of 31%.1

Unfortunately, today’s market afflictions are not fleeting. Investors may want to consider focusing on strategies that offer improved drawdowns compared with the market, but greater upside than targeted low volatility solutions. Investing with a defensive tilt may allow investors to weather upcoming risks—like Brexit, European Union Parliament elections, interest rates hikes and a potential slowdown in earnings—without needing to forgo income generation.

To learn more about these market insights, you can access our full monthly Chart Pack. You can also return to SPDR® Blog to get our timely views on evolving market trends. 

1Strategas Partners 11/6/2018


Bloomberg Barclays U.S. Aggregate Bond Index (the Agg)
A market-weighted index, meaning the securities in the index are weighted according to the market size of each bond type. Most US traded investment grade bonds are represented. Municipal bonds and Treasury Inflation-Protected Securities are excluded, due to tax treatment issues. The index includes Treasury, Government agency bonds, Mortgage-backed bonds, Corporate bonds and a small amount of foreign bonds traded in the US.

S&P 500 Index 
Standard and Poor's 500 Index is a capitalization-weighted index of through changes in the aggregate market value of 500 stocks representing all major industries. 

The tendency of a market index or security to jump around in price. In modern portfolio theory, securities with higher volatility are generally seen as riskier due to higher potential losses.

The income produced by an investment, typically calculated as the interest received annually divided by the investment’s price.