The monitor flashed quite a bit of red last month. But the market was seemingly undeterred and pushed higher anyway. Should this continue?
Fixed Income: 2-Yr Treas Yield 3.91% | 10-Yr Treas. Yield 3.91%
The bond markets saw volatility in August as questions mounted about an impromptu rate-cut by the Federal Reserve Bank (FRB). The most meaningful fall came at the beginning of the month. The perceived weakness in jobs data prompted a move to safety as expectations increased for a rate cut. At the time, people were calling for 0.50% before the September meeting. Cooler heads prevailed and the market is now expecting a 0.25% cut in September. The more impressive data point over the last month was the parody reached on the last trading day of August. This was the first time the two closed at parity since July 5th, 2022! It is still to be determined if rate normalization (higher rates on longer dated fixed income) will prevail. It is a good sign that the anticipated rate cuts are making a large enough impact for us to reach parity.
Equities: Dow Jones 1.76% | S&P 500 2.28% | NASDAQ 0.65%
The market moves that led to a strong month for fixed income signaled weakness for the equity markets. The Nasdaq lost almost four percent in the first week of the month to spend the next two weeks crawling out of that hole. The last week of the month saw the index continue to falter. Strong earnings from bellwether Nvidia (NVDA) was not enough to bolster confidence. Investors seemed to come to the realization that the FRB will likely take a slow methodical path towards rate reductions. That path did not buoy equity markets. In a retracement of the July trades, other major market categories failed to capitalize on weaker large caps:
S&P 400 (Mid Cap Index): 0.21%
Russell 2000 (Small Cap Index): 1.59%
Conclusion
It was, in all, a good month… That’s for two reasons, 1) fixed income made up ground that equities lost, 2) the spread between the 2-yr treasury and the 10-yr treasury reached parity. Something of a signal that the soft landing the FRB is looking for has been achieved. Generally, a recession (that would be evident by this point) would have caused a normalization of the curve.
A Look Ahead…
We see two key reasons to expect further volatility in equity markets during the next month:
- The 22.40 price to earnings (P/E) ratio for the S&P 500 will need to narrow further before markets can start a real rally.
- September is notoriously the worst month of the year for equities:
- 2023: 5.35%
- 2022: 8.92%
- 2021: 4.89%
- 2020: 4.12%
- 2019: 2.32%
Some logic would point to the high frequency in recent years being a signal that volatility should weaken in September. I find that unlikely given the elevated P/E referenced.
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Markets ended the week slightly down from the last. Rates were in focus, but should they be?
Monday
Markets were in the red most of the day only to surge into the green in the closing minutes. Monday was light on economic data, but this week will have plenty for investors to focus on. Retail sales report on Tuesday, the Federal Reserve Board (FRB) meeting ends Wednesday, and Friday will be busy for derivatives.
Tuesday
The movement for markets was mild on Tuesday, but still in the red. The FRB kicked off their two-day meeting. This is a hotly awaited meeting as investors eagerly await the FRB’s response to the recent rise in rates. If they respond with an operation twist it will be viewed as yield curve control. As the long end of the curve rises, we create gap to the next recession. This is because we increase the travel required to a yield curve inversion.
Wednesday
Markets ran in red most of the day. At 2PM that all changed. The FRB meeting adjourned with no change in rates as expected. The dot plot (individual member polling for future rate hikes) pointed to an increasing acceptance of rate hikes in 2023. This willingness to accept the reality of the recent rate surge helped markets push ahead.
Thursday
Everything reversed course on Thursday. While the FRB reaction yesterday was welcomed, Thursday the focus was on higher rates likely not fading. The 10-year treasury was above 1.75% for the first time since before the pandemic.
Friday
Markets were fairly range bound on Friday. What was poised to be an active day in the derivative markets proved to be a mundane end to the week. Markets ended the day moderately lower.
Conclusion
In all The S&P 500 ended the week lower. Driven by a rise in the 10-year treasury rate, ending the week at 1.74%. A high enough level to cause concern (specifically for the speed by which we got there). However, this is a low enough level that monetary conditions are viewed as extremely loose. Pre-pandemic, the lowest level the 10-year treasury had ever reached was 1.37%. With it merely .37% higher, there is reason to ask if too much is being made of the recent rise.
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Always remember that while this is a week in review, this does not trigger or relate to trading activity on your account with Financial Future Services. Broad diversification across several asset classes with a long-term holding strategy is the best strategy in any market environment.
Any and all third-party posts or responses to this blog do not reflect the views of the firm and have not been reviewed by the firm for completeness or accuracy.