Ghost of volatility past

Key Takeaways

• Volatility returns: October has brought a spooky uptick in market swings, driven by trade tensions and isolated credit concerns among regional banks.
• A tale of two banking tiers: While some regional banks have faced idiosyncratic credit and fraud issues, the largest banks continue to show strong earnings and resilient credit quality—reinforcing confidence in the broader financial system.
• The Federal Reserve (Fed) remains a stabilizing force: Should credit stress broaden, policymakers have a proven playbook and would likely act swiftly to preserve market stability.
• Deeper pullbacks would be viewed as an opportunity: After an extended rally and elevated investor sentiment, markets were vulnerable to negative surprises. We would view deeper pullbacks as opportunities to lean in, as the bull market still deserves the benefit of the doubt.

What happened?

After defying seasonal weakness in August and September, markets are now feeling the chill of October. Volatility has crept back in, with equity swings widening and pockets of weakness emerging, particularly among regional banks. Reemerging trade tensions between the U.S. and China and fresh credit concerns have spooked investors, leading to a more jittery tape.

The S&P 500 is down ~3% from recent highs, while small cap financials have plunged over 10%. The VIX—often dubbed the “fear gauge”—has doubled from its September low of 14 to an intraday high of 29. Meanwhile, gold has surged, and the 10-year Treasury yield has dipped below 4% for the first time since April, signaling a flight to safety.

Our take – A healthy scare, not a horror story

Despite an ongoing carousel of concerns, the bull market still deserves the benefit of the doubt. Our work had flagged short-term vulnerability given the sharp run-up, extended calm, and elevated investor expectations.

• The S&P 500 hadn’t seen a 1% daily decline in over 48 trading days—well above the post-2000 average of every 7 days.
• The last 5% pullback was in April, 120 days ago, versus a historical average of 77 days.
• Pullbacks are rarely comfortable, but they’re a normal part of the market cycle, and often arrive with unsettling headlines. Indeed, pullbacks are the admission price to the potential of stronger long-term returns.

Investor sentiment was notably bullish heading into earnings season. A recent BofA survey showed institutional investors at their most optimistic since February, and analysts raised earnings estimates heading into the quarter—an encouraging sign, but one that raised the bar for upside surprises.

From the April low to the October peak, the S&P 500 gained 35%, the sixth strongest six-month rally since 1950. Historically, such strength has been followed by positive returns over the next 12 months 90% of the time, though short-term weakness has not been uncommon.

Looking ahead, the next expected meeting between Presidents Trump and Xi isn’t until late October in South Korea, leaving room for tensions to escalate before they ease.

Credit quality divergence – A tale of two banking tiers

While credit spreads recently touched their tightest levels in years, isolated issues among regional banks—fraud-related write-offs and commercial loan stress—have triggered localized volatility and raised questions about underwriting discipline.

In contrast, the largest U.S. banks, which dominate the lending landscape, continue to show resilience. Q3 earnings reflected strong credit performance, stable consumer behavior, and a broadly healthy economic backdrop.

Should stress broaden, the Fed has a well-worn playbook and would likely act swiftly to contain systemic risk.

Technical levels

The S&P 500 (6629 as of 10/16) is currently testing near-term support around 6550–6600. A break below this zone could lead to a deeper pullback toward 6000–6100—near the 200-day moving average and a former breakout level. We would view that area as a potential opportunity for more aggressive positioning.

Portfolio implications

We maintain a U.S. large cap and growth bias. We remain neutral on small caps after upgrading them in August, though their heavier exposure to financials and regionals warrants monitoring.

Fixed income continues to provide ballast, reinforcing our high-quality bias. Further credit spread widening may present selective opportunities.

Gold remains a long-term diversifier, though with it now 31% above its 200-day moving average, the most stretched since 2006—the near-term risk/reward is less compelling.

Bottom line

October has brought a spooky gut check after an unusually calm stretch. But the primary uptrend remains intact, and we view deeper pullbacks as opportunities. Stay focused on the primary trend, stay diversified, and don’t let the headlines haunt your long-term strategy.

As always, we will continue to follow the weight of the evidence and keep an open mind.