MAIN EVENTS OF THE MONTH
In October, the Hamas terrorist attack on Israel was one of the major events. Many investors were concerned about how this conflict might impact equity markets. However, in reality, it had almost no effect, for example, on the prices of U.S. equities. While American equities did experience a decline, the primary driver was the increase in Treasury yields, reaching up to 5% on 10-year Treasury bonds. If this conflict does not escalate into a significant regional crisis, it is unlikely to have a major impact on equity markets, as historical U.S. data (shown in the chart on the right) suggests. The chart illustrates the real value development of U.S. equities.
A 5% yield on U.S. Treasuries creates strong competition for riskier asset classes, such as equities. Investors will expect higher returns from equities compared to periods of zero bond yields. And how can equities deliver higher returns? Either through significantly increased corporate profitability or by a decline in stock prices. In Europe, expectations of a rapid decline in ECB rates appear to be more wishful thinking than reality. Overall, it seems that interest rates are returning to the normal levels that prevailed for most of the past. The last 15 years were simply an anomaly.
Turning to emerging markets, the situation in China remains stagnant. Global foreign funds continue reducing their investments in Chinese equities. According to Morgan Stanley, the average investment of these funds has dropped to its lowest level since 2020. The reasons include tense relations with the U.S. Moreover, not only funds but also retail investors are starting to exit China. The hopes for a sharp economic recovery after the end of stringent anti-epidemic measures have not materialized. Due to declining U.S. equity prices, we once again found ourselves in an interesting discount range at the end of October. The fair value indicator from Morningstar below shows whether equities are cheap (blue band), expensive (orange area), or fairly priced (black line).
Equity markets followed the declines of previous months. Nervousness related to rising U.S. Treasury yields impacted equity prices not only in the U.S. The global equity index MSCI World fell by 3.0% in USD for October, the S&P 500 dropped by 2.2% in USD, and the broad European index STOXX Europe 600 recorded the most significant decline among these indices, losing 3.8% in EUR.
Blue line – Performance of the U.S. S&P 500 Index over 19 years in USD
Red line – Performance of the global MSCI World Index over 19 years in USD
Green line – Performance of the European STOXX 600 Index over 19 years in EUR
IMPACT ON OUR PORTFOLIOS
For portfolios with equity components consisting of shares in developed world companies, October was one of the months where the equity portion declined. The performance of the bond component depended on the type of bonds invested in. For instance, 10-year Czech government bonds saw a slight price increase due to a decline in yields. In contrast, U.S. Treasury bond prices decreased as their yields rose. If a portfolio was not significantly weighted toward Czech government bonds, the overall portfolio value declined again. Unlike the previous month, the weakening of the Czech koruna against the U.S. dollar did not provide a cushion. As a result, equity investments in dollars yielded the same return for unhedged Czech investors.
Maintaining an unhedged currency exposure in the equity (dynamic) portion of a portfolio still seems like a viable strategy. In times of crisis, investors typically flock to the U.S. dollar, which often strengthens it and weakens the Czech koruna. This dynamic helps limit the decline in the equity portion of a portfolio invested in the developed world (primarily in the U.S.) during times of crisis.
