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 climbed nicely last week on the back of earnings, but is there a storm brewing?
Monday
In mixed market activity, the S&P 500 rose 0.3% on the day. Markets opened in the red and managed to climb their way out. The week opened, as many have recently, where the focus was on inflationary pressures. This gave way to earnings, which continue to out-perform. Reporting is still focused on financials but shifting towards technology.
Tuesday
Markets climbed on Tuesday as the S&P 500 added 0.75% on the day. Building permits disappointed on the day, shrinking by 7.7%. Driving markets higher was earnings strength as a much heavier swath of companies reported in comparison to Monday. All major earnings (that came in before close) beat market expectations.
Wednesday
The climb continued on Wednesday with the S&P 500 rising 0.37%. Earnings continued to be in focus as 78% of major reporters beat expectations and 61% beat on revenue. A low percentage of S&P 500 companies have reported, but the season is starting with good strength.
Thursday
Although mild, the S&P 500 managed to rise for the seventh straight session, adding 0.26%. Initial jobless claims fell to their lowest level since the start of the pandemic at 290K. Normal pre-pandemic levels were around 200K. On-going unemployment claims have fallen by about 100K each week over the last 5 weeks. This could mean a strong jobs report for October (released on the first Friday of November).
Friday
Markets opened in the green but reacted adversely to comments from Federal Reserve Board (FRB) chair Powell. He admitted that inflation is persisting longer than the FRB has expected. This admission removes the term transitory from the conversation. The word that the FRB has been feeding markets for about 10 months. He expressed that the expectation is for inflation to begin to pull back to more normal levels late next year. He also indicated that the FRB intends to begin tapering shortly and be completed by the middle of next year. So, that type of accommodation should be fully removed earlier than previously anticipated. This was digested by investors as a more hawkish stance by the FRB.
Conclusion
The S&P climbed fairly nicely across the week courtesy of an earnings season that is starting stronger than expected by investors. The statements by FRB chair Powell may have lasting reverberations into next week. Watch fixed income markets for stress from potential updated expectations for when the FRB may start to raise interest rates. Bank of America has already updated their forecast to late 2022. Additionally, the unresolved debt ceiling still looms large for the third of December…
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