Stocks declined for a third straight month in October. A U.S. inflation report released early in the month showed consumer prices rose more than expected in August. Persistent inflation implies interest rates will remain higher for longer, which could make stocks less attractive on a relative basis.

Impacts of inflation

With rate cuts looking increasingly unlikely in the next few quarters, investors began demanding higher rates for holding longer maturity issues, causing losses in long-term bonds, and flattening what has been an inverted yield curve. A positive take on the inflation report is that a significant amount of the increase was due to home rental prices, which have recently shown signs of moderating; this will take some time to filter into official data.

Highs & lows of stocks

The so-called “Magnificent Seven” mega-cap tech stocks posted mixed results for the month. Alphabet Inc. (Google) fell when it released earnings despite strong overall growth. This highlights the lofty expectations these tech darlings now face. Tesla was also down sharply, but Microsoft gained on robust cloud revenue growth.

Small cap stocks once again underperformed for the month, finishing the period in negative territory for the year. Small caps are more volatile, and investors are often rewarded over time for assuming that risk. Strong rallies can materialize out of seemingly nowhere.

A word on sentiment

Recently, we detected what feels like a notable shift in sentiment among retail investors. The combination of multiple wars, inflation, political divide, and debt concerns have understandably created a dour environment. Some are seeing the higher yields in cash or bonds and feel an urge to go to the sidelines. We encourage investors to avoid emotional reactions that can lead to big mistakes.

The long-term fundamental drivers of equity gains (earnings growth and money supply growth) remain in place. We do not have a short-term forecast for stocks but note that equity markets frequently love to climb a wall of worry, so it is possible the turn in sentiment will prove to be bullish. Meanwhile cash, while more attractive than a year ago, faces both inflation risk and reinvestment risk if rates decline again.

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