As hinted in the last column, October turned out to be a tough month across most markets. In the United States, worries about inflation, slower earnings and economic growth dominated sentiment. In addition, an unexpected event shook investors: the meltdown of Refco, one of the largest commodities and futures brokers in the world. Refco went into bankruptcy when customers began withdrawing assets after chief executive Phillip Bennett was charged with securities fraud on October 12 for allegedly hiding a $430 million debt from the company. The company put Bennett on leave October 10, when it revealed the debts.
While the news took most investors by surprise, even more intriguing was the fact that markets recovered somewhat well from the news. For months now, many strategists and portfolio managers have expected a systemic event, similar to what happened during the Asian crisis or the Long-Term Capital Meltdown. In spite of several recent high profile bankruptcies, scandals and lawsuits, the financial system itself has held up pretty well. Credit spreads, which give a clue about investors’ current level of risk-appetite, still indicate that markets participants are comfortable with the current environment. In addition, thanks to the Federal Reserves’ “telegraphed” rate hikes, the bond market has survived incremental rate hikes for 12 months in a row.
On the other hand, a lack of major dislocations did not translate into rosy returns. Stock markets globally faired quite poorly in October. In the United States, the S&P 500 lost -1.8%, the Dow Jones Industrial Index lost -1.2% and the Nasdaq -1.5%. Japan (Nikkei +.24%) and Europe (Dow Jones Stoxx 50 -1.8%) also experienced disappointing returns. As in September, the equity markets’ poor performance took place in spite of lower oil prices (crude lost $5 to finish the month around $60/barrel).
If you find the current markets puzzling, do not despair. Even hedge-fund managers are struggling these days. While most funds won’t report numbers to their investors until later in the month, anecdotal evidence is pointing to losses from -3% to -4%, with some as high as -8 to -10%. In particular, long/short equity managers (who place bets on rise and fall of equities, generally based on sound fundamental analysis) seem to have taken a beating. These managers generally focus on smaller public companies, an area that was punished particularly hard in October, mainly because of concerns about those companies’ ability to withstand a slowing economy, the Katrina effect and rising interest rates.
On the bright side, investors can look at 2004 for hope. Last year’s returns were generally disappointing heading into the fourth quarter. Thanks to a “Santa Claus Rally,” many portfolio managers were able to finish the year in positive territory. It could mean good news for your portfolio if we see a repeat of 2004. Either way, some investment styles, such as Global Macro – an investment strategy based on trends in the global economy – are well positioned to keep generating strong returns whether markets finish with a rally or a slowdown.