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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The Federal Reserve would like to hike at a fever pitch. What did last week tell us about their ability to do so?
Monday S&P 500 2.95% | NASDAQ 3.62%
The weekend yielded enough negative news to give us a red Monday. Continued failure of ceasefire agreements spells uncertainty, which the market loves… More and more companies are coming out against Russia’s actions, resulting in more supply chain issue expectations. Interestingly, yields rose with the market fall. This was as a result of inflation concerns that would stoke the need for additional Federal Reserve Board (FRB) action.
Tuesday S&P 500 0.72% | NASDAQ 0.28%
The United States announced an embargo on Russian oil imports. Meanwhile, actions out of Europe were more measured. The UK announced a phase out, while the EU announced a 2/3 reduction by year end. Markets travelled between green and red all day, but one thing was consistent: the NASDAQ outperformed the S&P 500. This marks a deviation from recent norms.
Wednesday S&P 500 2.57% | NASDAQ 3.59%
In a stark contrast to the first few days of the week, Wednesday surged greatly. The move represents investor fears that inflation will persist, and the FRB will be able to do little about it. The inflation source will be fuel/food, which will erode consumption: the same net effect of an FRB raising interest rates. Bottomline, when you are spending on gas, you are less likely spending elsewhere.
Thursday S&P 500 0.43% | NASDAQ 0.95%
Investor sentiment was decidedly sour at the open as markets were down more than 1% at points. They rebounded late to cut losses. This happened in the face of a stalemate in talks over Ukraine. The driver was a statement by Putin that gave hope that oil shortages may not occur. He indicated that they would honor all energy commitments (even with countries that are not aligning with them). This brings hopes of contained inflation, which would keep from eroding consumer spending.
Friday S&P 500 1.29% | NASDAQ 2.17%
Markets spiked at open but faded throughout the day. Markets accelerated their losses into the close. Hurting confidence from the start of the session was weakening Consumer Sentiment. It had fallen to the low 70’s when the pandemic began, but it is now projected into the high 50’s. This is a level not seen since mid-2011, when the US breached the debt ceiling. Additionally, energy prices provided pressures to the market concerning investors that inflation would remain pervasive. The see-saw around oil prices will continue to drive investor sentiment until more certainty is known about Ukraine’s future.
Conclusion S&P 500 2.88% | NASDAQ 3.52%
The week looked much like the last several. The NASDAQ fell harder than the S&P 500 as inflation concerns make an FRB rate hike all but certain. This would mark the second lift off for the FRB over the last 7 years. During the last rate hike environment, the FRB increased the rate from 0.0% to 2.25% – 2.5%. The move took four years to happen. This time it is expected by many that the FRB would make that same progress in about one years’ time. This is why the aggressive repricing of stocks occurred at the start the year. Investors are pricing in the impact higher rates will have on earnings. Realistically, headline risk evolves and may cause reason for pause over time. FRB progress to 2.5% would likely take two years given headline risks.
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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.