October was a bruising month for investors, caught on the wrong side of violent price swings across a wide range of markets. By many measures of position shifts, trading volume and fund performance, it was a historic month.
The question now is whether the shakeout has cleared the decks for investors to load up again on the bets they had been making - such as long stocks and short bonds - or whether the damage done is so severe that capital preservation for the remainder of the year is now paramount.
According to Bank of America Merrill Lynch, in “Red October” a conventional 60/40 portfolio of U.S. stocks and Treasury bonds lost 5.3 per cent, the worst monthly return since February 2009.
Hedge funds, in particular, bled heavily. Reporting from 278 funds shows that the Barclayhedge Hedge Fund Index lost 2.71 per cent, its worst month since January 2016 and the second worst in at least five years.
It was enough to wipe out all year-to-date gains, putting the index down 1.54 per cent for the year.
Some sub-indices fared even worse. Preliminary data shows the Emerging Markets Index slumped 4.02 per cent, taking year-to-date losses to 11.25 per cent, and the Equity Long Bias Index fell 4.38 pct.
Hedge fund performance tracker Eurekahedge hasn’t provided data for October yet but its broadest Hedge Fund Index was up only 0.13 pct for the year at the end of September. It will almost certainly be in the red now.
A cocktail of worries over global trade and protectionism, Italy’s budget plans and rising U.S. interest rates triggered major reversals across many markets last month.
The MSCI world equity index fell 7.57 per cent, its worst month since May 2012; the S&P 500 fell 6.94 per cent, its worst month since September 2011; and the MSCI emerging equities index fell 8.8 per cent, its worst month since August 2015.
Figures from the Washington-based Institute of International Finance estimated investors pulled a gross $17.1-billion out of emerging stocks in October, making it the worst month since the ’taper tantrum’ in May 2013 and the fourth worst month since its records started in 2005.
Analysts at JP Morgan reckon long/short equity hedge funds and risk parity funds have room to raise their equity exposure, “assuming the news flow stays positive,” while commodity trading advisers “should not be far from neutral” now.
That could help stocks recover some of that lost ground. World stocks had their best week last week since February, and emerging stocks rallied 6 per cent, the most since February 2016.
But longer-term, institutional investors are still heavily long equities relative to bonds, “and the October correction has done little in reducing their big equity overweight (position),” meaning there may be more downside for stocks, they say.
If the shift in equities last month was a dramatically bearish one, it was an equally bullish shift in bonds.
Figures from the Commodity Futures Trading Commission figures for the week ending Tuesday, Oct. 30 show hedge funds and speculative accounts cut their net short position in 10-year Treasury futures by 41,194 contracts to 502,839 contracts.
This was the fifth week in a row they had reduced their wager that U.S. bond prices will fall, bringing the shift from a record net short 756,316 contracts in late September to 253,477 contracts.
That’s the biggest monthly move towards a more bullish or less bearish position in Treasuries since April last year, and the fourth largest since CFTC data was first compiled in 1995.
High yield “junk” bonds, often seen as the canary in the coal mine warning of looming danger in markets at large, flashed their warning signs. U.S. junk bonds had their worst month in almost three years in October, and on heavy volume too.
Bond trading platform MarketAxess said high yield trading volume in October was a record $20.3-billion, which contributed to an overall total trading volume across all fixed income of $164.4-billion. That was also a record.
The shakeout last month was severe. Early signals this month point to stabilization and even tentative recovery. But sentiment is fragile, and further waves of volatility and hefty price swings would come as no surprise.