November 2019

A Fed rate cut, optimism on the China trade front and corporate earnings that were just good enough, drove positive returns across nearly all market segments in the month of October.

  • International equities led the way, with emerging-market stocks returning 4.2% and international developed market equities returning 3.6%.
  • U.S. large-cap stocks returned 2.2%, small caps 2.0% and mid caps 1.1%.
  • While the Fed cut the fed funds rate 25 basis points (bps), longer-term U.S. Treasury yields were relatively steady, and the U.S. Aggregate Bond Index posted a 0.3% return.

U.S. mid caps: The forgotten asset class

For nearly a decade, mid caps have become steadily cheaper relative to large cap stocks and now trade at more than a 35% price-to-book discount.

Source: Bloomberg, 10/31/2009 to 10/31/2019


Nearly all market segments posted positive returns for the month of October.

Returns of various common market segments

Source: Bloomberg

Don't Overlook Mid Caps

Most investors acknowledge the importance of owning small-cap stocks to complement their large-cap holdings, but many skip over the stocks in the middle—mid caps. For those who have left mid caps out of their portfolios, it’s a missed opportunity. Since its launch on July 1, 1991, the S&P MidCap 400 has returned 11.8%, outperforming both the S&P 500 and the Russell 2000, which have returned 9.8% and 9.5% respectively. As a reminder of the power of compounding, that amounts to a cumulative total return that is 1.7x that of the S&P 500 and 1.9x the return of the Russell 2000.

Of late, however, mid caps have underperformed—in fact, by over 5% over the last 12 months. As seen in the chart of the month, this past year punctuates a nearly 10-year period of mid caps becoming cheaper relative to large caps; mid caps now trade at more than a 35% price-to-book discount.

An Approach to the Mid-Cap Opportunity

Investors looking to take advantage of this opportunity are right, however, to be concerned about an economy that may be weakening, earnings growth that is virtually nonexistent, and the outsized impact that can have on mid-cap stocks. In the Q4 2018 sell-off, as an example, the S&P 400 declined 17.3% compared with 13.5% for the S&P 500. An approach to mid caps that focuses on dividend growth offers a potential answer.

In that Q4 sell-off, the S&P MidCap 400 Dividend Aristocrats fell only 8.5%—less than large-cap stocks. Quality is the key driver. The S&P 400 Dividend Aristocrats have higher gross margins, net margins, return on assets and return on equity than the overall S&P 400. And, hot off the presses, with more than two-thirds of companies reporting Q3 2019 earnings as of November 1, 2019, the S&P 400 Dividend Aristocrats have generated 3% earnings growth. That may not sound like much, but it’s a lot better than the 2% decline posted so far for the S&P 400. For investors looking to add or initiate mid-cap positions in their portfolios, quality dividend growth stocks deserve a look.

Inflation Has Been Falling

The Fed cut the federal funds rate for the third time this year in October. While geopolitical risks—most prominently Chinese trade tensions—were certainly an ingredient in this decision, there is a more direct driver: Inflation has been falling. The core Personal Consumer Expenditure (PCE) Deflator, the Fed’s preferred measure of inflation, has fallen from 2.1% in July 2018 to 1.7% for September 2019, the latest reading. The Fed targets 2% inflation. If inflation is running below 2%, the standard response is to ease monetary policy to stimulate the economy and push inflation back up. If the Fed is successful in its efforts, inflation will rise, and with it, more often than not, longer-term interest rates.

The core Personal Consumer Expenditure (PCE) Deflator index measures the prices paid by individuals for goods and services, excluding food and energy.

Despite the Inflation Drop, Can Interest Rates Still Rise?

But what if the Fed is not successful? There are many who are skeptical of the Fed’s ability to increase inflation. Some point to global economic weakness, some to structural changes in the economy or demographic changes, to suggest that it will be extremely difficult to generate higher inflation. If inflation doesn’t rise, can longer term interest rate still rise? The answer is yes.

Over the same period that the core PCE Deflator has fallen around 40 bps, the yield on the U.S. 10-year Treasury has fallen over 110 bps. An incredibly simplistic—but perhaps not misguided—answer to the interest rate question is that the 10-year Treasury yield could rise more than 70 bps just to get back to the same real rate of just over a year ago. That could drive losses of 5% or more in a longer-duration bond. And that’s if inflation remains this low, and before we discuss our favorite topic of how extremely low these real yields are from a historical context—even if they rose another 50 or even 100 bps. The yield on the 10-year U.S. Treasury has crept up modestly since the lows of the summer. There may be more to come.

Source for data: Bloomberg.

Indices are unmanaged, and one cannot invest in an index. Past performance does not guarantee future results.

Any forward-looking statements herein are based on expectations of ProShare Advisors LLC at this time. Whether or not actual results and developments will conform to ProShare Advisors LLC's expectations and predictions, however, is subject to a number of risks and uncertainties, including general economic, market and business conditions; changes in laws or regulations or other actions made by governmental authorities or regulatory bodies; and other world economic and political developments. ProShare Advisors LLC undertakes no duty to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Investing involves risk, including the possible loss of principal. This information is not meant to be investment advice.

Bonds will decrease in value as interest rates rise. International investments may also involve risks from geographic concentration, differences in valuation and valuation times, unfavorable fluctuations in currency, differences in generally accepted accounting principles, and economic or political instability. In emerging markets, many risks are heightened, and lower trading volumes may occur.

Information provided by ProShares and SEI Investments Distribution Co., which is not affiliated with ProShares.