Emotionally intense event, the Hamas attack on Israel, surprisingly did not have a major impact on stock markets. In the US, the rise in US Treasury yields to 5% was the main driver.
MAIN EVENTS OF THE MONTH
In October, the Hamas terrorist organization's attack on Israel was among the main events. Many investors were concerned about how this conflict would affect the stock markets. However, in reality, it had little effect, especially regarding the development of US stock prices. While American stocks did decline, the primary driver was the rise in yields of government bonds, reaching 5% for the 10-year Treasury note. If this conflict doesn’t escalate locally, it should not significantly impact the stock markets, as historical data in the USA has shown, as depicted in the graph on the right, illustrating the development of the real value of American stocks.
A 5% yield on US Treasury bonds creates significant competition for riskier asset classes, such as stocks. Investors will expect higher returns than during periods of zero interest rates on bonds. Looking at Europe, expectations of a rapid decline in ECB rates seem more like wishful thinking than reality. Overall, interest rates seem to be returning to the normal levels that prevailed for most of history. It's just the last 15 years that we seem to have forgotten about it.
Turning to the developing world, it's worth mentioning the situation in China, which is not improving. Global foreign funds continue to reduce their investments in Chinese stocks. According to Morgan Stanley bank, the average investment of these funds has dropped to the lowest level since 2020 due to strained relations with the USA. Not only funds but also small investors are starting to flee China. Hopes for a sharp rebound in the Chinese economy after the end of very strict anti-epidemic measures were not fulfilled.
Due to declines in US stock prices, we found ourselves in an interesting discount zone at the end of October. The fair value indicator from Morningstar below shows whether stocks are cheap (blue zone), expensive (orange area), or at a fair price (black line).
Stock markets followed the declines from previous months. Nervousness surrounding the rise in US bond yields affected stock prices not only in the USA (as per the blue line - performance of the S&P 500 over 19 years in USD), but also globally, as depicted in the red line (performance of the MSCI World index over 19 years in USD), and in Europe (green line - performance of the STOXX 600 index over 19 years in EUR).
Impact on our portfolios
If our stock component of the portfolio consists of shares in companies in the developed world, October saw a decline in the stock component. The performance of the bond component depended on the bonds we invested in. For example, 10-year Czech government bonds saw a slight increase in price due to a decline in yield. Conversely, the price of US government bonds fell due to an increase in their yield. Unless our portfolio was significantly biased towards Czech government bonds, there was again a decline in the portfolio's value as a whole. This month, unlike the previous one, there was no help from the weakening of the Czech koruna against the dollar. Therefore, dollar-denominated stock investments had the same return for a Czech investor without hedging.
However, it still appears to be a suitable strategy not to hedge currency risk in the stock (dynamic component) of the portfolio. In times of crisis, investors tend to turn to the dollar, usually causing its appreciation, consequently leading to the depreciation of the Czech koruna. This means that the stock component invested in the developed world (especially in the USA) doesn’t decrease as much in times of crisis.
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