Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 90

Reflections on markets in October 2014

Looking at month-to-month outcomes, October 2014 could be filed away as another month of reasonably normal returns. However if you lived through it day-to-day, there was lots of volatility and events, including somewhat of a ‘mini-panic’. Perhaps it’s better to ignore the detail! However, markets are dynamic and learning opportunities should not be ignored. A recent business trip to the US gave me a chance to reflect, leaving as many questions as answers.

Reasons for the mini-panic were not new

The performance path for October 2014 for US and Australian equities is presented below.


Source: Bloomberg

It looks like October was a non-event in Australia (falling only 2% by mid-month), but recall that Australian stocks were already close to 7% off their highs heading into October.

There were no real new reasons for the mini-panic during the first half of October. I title it a ‘mini-panic’ as the VIX index (a measure of implied market volatility, commonly known as the ‘fear index’) rose sharply before subsiding. The threat of Ebola, global security issues, strong USD, concerns of a European triple dip recession, further weakening in China, market over-valuation, inevitable rate rises in the US … the market was well aware of these issues. So what started the October mini-panic? When it comes to market triggers, we often don’t know. It can be as simple as a couple of larger market participants selling down and this spooks others into action.


Source: Bloomberg

Overvalued equity markets but interest rates are so low

On many measures equity markets are overvalued. In the US in particular, profit margins are at abnormally high levels, so any reversion to this component makes US companies appear even more overvalued. The chart below is one of many valuations of the US equity market.


Source: Morgan Stanley Investment Management Global Multi-Asset Team analysis.

When valuations are stretched it feels like minor falls can turn into major market corrections. But while interest rates remain at extraordinarily low levels, it is difficult for equities to fall significantly as investors are reluctant to accept the alternative of zero return guaranteed. October proved the same when sharemarket falls in the first half of the month were accompanied by falls in bond yields (suggesting lower interest rates for longer) which attracted investors back to equities. These are uncomfortable times for asset allocators who focus on fundamentals.

Bonds provided diversification during the mini-panic

Like many market observers I constantly worry that at some point bond yields will sell-off and this will cause a sell-off in equities at the same time. This structural break in the historical correlation between equities and bonds would create a difficult environment for investors (such an event has occurred in the past). Traditional diversification will have failed. However October proved not to be this case: equities fell and bond yields rallied and so the status quo was preserved. I can rationalise this: while short term interest rates are very low in the US, bond yields are a fair bit higher (so the yield curve is reasonably steep). This leaves room for bond yields to rally reflecting a market view, not that interest rates will fall, but that interest rates will be lower for longer. The rationalisation in my mind is that the risk of traditional diversification failing is more nuanced: while the yield curve is steep, and if the negative catalyst is an economic growth concern, then the traditional relationship (diversification) between equities and bond yields may well still continue. If the curve is more flat or the catalyst is rising interest rates then the traditional relationship will be challenged.


Source: Bloomberg

Hedge funds struggled but don’t write them off

Hedge funds struggled in October. There were some idiosyncratic events (two large trades common to many managers experienced adverse events – AbbVie’s takeover of Shire and a ruling on Fannie Mae/Freddie Mac preference shares) were just an unfortunate coincidence with October’s events. But months like October (a mini-panic and then a strong recovery) are difficult for hedge fund managers because many cut risk in response to market falls and rises in volatility. So hedge funds locked in some of their mid-month losses whereas traditional long-only equity fund managers recovered all of their losses. That said I wouldn’t write off hedge funds. Such an approach to risk management has the potential to protect them in an extremely difficult environment.

Market structure has changed: watch your liquidity

The structure of the market (the mixture of market participants) constantly changes. It is an area which requires ongoing monitoring. One of the big themes has been the reduction in bank proprietary capital. Deprived of capital banks now carry less inventory. This means that when you go to transact in a security like a high yield bond, the bank is less likely to exchange with you directly (on their own balance sheet) and more likely to be an arranger of a sale by finding another interested counterparty. This can negatively affect liquidity.

For example, there has been a massive inflow of capital into high yield bond funds and ETF’s by retail investors, as shown in the first graph below, presumably chasing the higher yields on offer. The underlying funds offer daily liquidity. So the potential availability of liquidity is lower and the potential demand for liquidity is higher. This doesn’t sound appealing to me. Redemption expenses could be higher and there is an increased potential for larger market events. However October didn’t test this change in market structure: because high yield bonds are fixed rate and interest rates rallied, high yield bonds performed reasonably and outflows were not substantial. In my assessment a good risk manager would mark their high yield exposure as less liquid and having a larger negative skew to its return distribution.


Source: EPFR; IMF; Bloomberg LP; Morgan Stanley Investment Management Global Multi-Asset Team analysis.

Markets like October provide useful lessons

While October 2014 market behaviour proved to be a mini-panic which was quickly recovered, it created useful insights. Thinking through the issues, working out the appropriate balance between return and risk, and watching for emerging risks and regime changes are what makes the job of a portfolio manager so fascinating.

 

David Bell is Chief Investment Officer at AUSCOAL Super. This article is for general educational purposes and is not personal financial advice.

 

RELATED ARTICLES

The two key risks facing investors

Cyclical stocks will drive markets higher in 2025

Clime time: why this time really is different

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Latest Updates

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Economy

Australia's economic report card heading into the polls

Our economy grew by a nominal rate of 7% per annum from 2017 to 2024, but it benefited from the largesse of fiscal and monetary policies, both of which are now fading. We need a new, credible economic growth agenda.

Preference votes matter

If the recent polls are anything to go by, we are headed for a hung parliament at the upcoming federal election. So more than ever, Australians need to give serious consideration to their preference votes.

SMSF strategies

Meg on SMSFs: Tips for the last member standing

It’s common for people as they age to seek more help in running their SMSF if their capacity declines. An alternate director may be a great solution for someone just planning for short-term help in the meantime.

Wilson Asset Management on markets and its new income fund

In this interview, Matthew Haupt from Wilson Asset Management discusses his outloook for the ASX, sectors such as REITs that he likes, and his firm's launch of a new income-oriented listed investment company.  

Planning

‘Life expectancy’ – and why I don’t like the expression

Life expectancy isn't just a number - it's a concept that changes with survival rates over time. This article breaks down how age, survival, and societal factors shape our understanding of life expectancy, especially post-Covid. 

The shine is back on gold, and gold miners

Gold mining stocks outperformed in 2024 and are expected to do well in 2025. At this point in the rally, it's worth considering what has driven gold prices higher and why miners could still have some catching up to do.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.