October has so far lived up to its scary reputation, with markets displaying nervous uncertainty. Equity and bond markets face several headwinds, including hotter-than-expected inflation, elevated energy prices and Treasury yields near their highest levels this year. Even so, the S&P 500 remains up by about 12% year-to-date, although the index has largely traded sideways since August.
Sector performance also points to caution. Energy and technology still lead for the calendar year, with both up more than 20%. Energy has retained its lead this month, while defensive sectors such as consumer staples, healthcare and utilities have gained as investor concern has increased. By contrast, technology has been the month’s worst-performing sector and has fallen into negative territory.
Several factors have driven the technology sector lower. One is the sell-off in AI companies with elevated debt and limited free cash flow to support their borrowing, including CoreWeave and Oracle. Investors are increasingly concerned that revenue growth across the AI sector may not match their lofty expectations, a view reinforced by recent revenue reports from companies such as Anthropic and OpenAI. This concern has weighed heavily on technology subsectors, including semiconductors. Higher interest rates are adding pressure, particularly as debt financing accounts for a growing share of capital expenditure.
Investors have therefore moved towards more defensive areas of the market. Value stocks have also performed better as investors have sought safer assets. This rotation suggests a growing preference for quality and defensive investments amid persistent headwinds. Nevertheless, several strong fundamentals continue to support the broader equity market expansion.
Market volatility is common in October. In a typical year, stock markets experience between one and three pullbacks of 5% to 15%. So far this year, there has been only one: a 10% decline in March, when the US–Iran war began. Although further volatility is possible, three fundamental pillars are likely to help equity markets through this period.
First, earnings growth among S&P 500 companies remains strong and is on track to exceed 30% this year – the highest rate since 2021, when the economy was emerging from the pandemic downturn. Although a sharp slowdown is forecast for 2027, strong earnings currently underpin share prices and remain an important source of support for equity markets.
Second, US economic growth remains robust despite rising interest rates and elevated inflation. Both manufacturing and services have expanded this year, with Purchasing Managers’ Index readings remaining above 50, the level that indicates growth.
Third, US consumers have remained resilient. Recent data indicate that household spending is healthy. September retail sales, reported last week, rose 0.8% during the month – more than double the 0.3% forecast – as households continued to spend despite rising prices. Major US banks have also reported solid consumer spending and credit conditions, supported by a steady labour market. Because consumption accounts for about 70% of US GDP, resilient consumers are a positive sign for the wider economy.
Given these fundamentals, we do not expect a recession or economic downturn in the near term. Market swings and occasional setbacks remain likely, but strong corporate earnings, resilient growth and healthy consumer spending continue to support US equities. That outlook could change quickly, however, if uncertainty over inflation, oil prices and geopolitical risks increases.
Attacks on Saudi infrastructure and shipping in the Strait of Hormuz intensified last week. Concerns about further action against Iran also weighed heavily on investor sentiment and financial markets. Together, these developments are keeping energy prices elevated and placing pressure on countries that rely on energy imports.
In the UK, investors are awaiting the Labour government's first budget, with markets awash with speculation over possible tax and spending measures. Nevertheless, UK GDP expanded by 0.1% in August, outperforming expectations for a 0.1% contraction. Manufacturing production, meanwhile, jumped 1.2% month-on-month, while industrial production rose 0.8%. The monthly trade deficit also narrowed.
In Asia, markets such as South Korea were hit hard by the global sell-off in semiconductor and AI-related stocks due to their heavy exposure to companies such as Samsung Electronics and SK Hynix. The KOSPI (South Korea's main stock market index) initially declined to a six-month low, prompting a temporary trading halt, but has since recovered much of those losses.
As we enter the final quarter of the year, we are focusing on three issues that could become important catalysts in the weeks ahead. First, we will watch earnings reports from the largest technology companies, paying particular attention to management commentary on AI investment, revenue growth and the sector’s increasing use of debt financing. Reassuring guidance, sustained revenue growth and robust returns on investment would probably prompt a favourable response from investors.
Second, the US Federal Reserve’s next interest-rate decision will be important. The key question is whether policymakers will hold rates steady and signal gradual future tightening, or point to a more immediate need for further increases. Investors will scrutinise the Federal Reserve’s assessment of inflation, the labour market and the wider US economy.
Third, the US midterm elections are on 3 November. Politics and elections alone do not usually determine stock market fundamentals, although divided government has historically created headwinds. Since 1970, US stock markets have typically risen in the six months following midterm elections, regardless of the outcome.
Market volatility and shifts in investor sentiment during October have unsettled many investors. So far, declines in technology and AI-related shares, combined with higher-than-expected inflation and rising bond yields, have led to significant market losses, particularly across Asia. Still, the S&P 500 remains near record highs, suggesting a rotation rather than a broad bear market. Looking ahead, stock market performance in November and December is likely to be driven by corporate earnings results, movements in oil prices, and any interest-rate decisions or guidance from the Federal Reserve.
Overall, strong corporate earnings, solid economic growth and resilient consumer spending continue to support the equity market expansion. We therefore continue to favour quality equities over fixed-income investments, although that preference could change if yields rise further.
By region, we continue to favour US equities, particularly large- and small-cap companies, which provide a balance of growth and defensive characteristics. We would also look to increase exposure to Asia and emerging markets if further market weakness creates more attractive valuations, while remaining selective in Europe and the UK. Within fixed income, we favour shorter-term bonds, which are less sensitive to interest-rate movements. Within alternative investments, we see attractive opportunities in infrastructure assets that can provide stable income and diversification.
While market volatility may continue in the coming weeks, your financial adviser can help ensure that your portfolio remains aligned with your long-term financial objectives, risk profile, and investment timeframe.
