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 rose last week, and optimism was a bound early in the week. Was it misguided?
Monday S&P 500 2.59% | NASDAQ 2.27%
Markets opened the week in stark contrast to how they ended last week (and month). The sad part was that the move higher for equities came on signals that the US economy weakened. It was a move that signaled an expectation of a less hawkish Federal Reserve Bank (FRB). As of late, rallies of this type have been very short lived.
Tuesday S&P 500 3.06% | NASDAQ 3.34%
The rally continued for a second day. The strength of these increases is concerning as a reversal day would likely be just as deep. The moves to the north are happening under a false hope of a pivot from the FRB. This came as the Royal Bank of Australia delivered a smaller increase than expected. Additionally, after the UK removed a tax cut for the wealthy, interest rates began to retreat. This reaction was merely a reversal on the rate increases after the policy was announced a week ago. The FRB very plainly told markets on 8/26 not to expect a pivot until inflation has been beaten. With inflation siting above 8%, it seems unlikely to consider that beaten. This rally will likely be short lived.
Wednesday S&P 500 0.20% | NASDAQ 0.25%
The shine on the two-day rally came off a little on Wednesday. 10-year yields bounced back up and equities opened deep in the red. The good news is that throughout the day, equities managed to claw all the way back to even.
Thursday S&P 500 1.02% | NASDAQ 0.68%
Equities turned lower on Thursday as FRB governors are echoing the hawkish stance of the Bank. Additionally, initial jobless claims rose, however, it was a slight increase. 219K job losses is a pace that signals a strong job market. The number will likely increase to 300K or higher in a recession.
Friday S&P 500 2.80% | NASDAQ 3.80%
Happy Jobs Friday! Markets tumbled to close out the week. The jobs data was strong as the unemployment rate crept down to 3.5% on 263,000 non-farm payroll additions. The FRB is looking for the rate to increase and for job adds to slow closer to break even. Inflation will likely continue to be an issue awhile unemployment remains below 4% to 4.5%.
Conclusion S&P 500 3.01% | NASDAQ 0.73%
Equity markets rose for the week. Something that has been rare as of late. The rise, however, is seeming short lived as it was mainly from the first two trading days of the week. The rest of the days represented a claw back of those gains. The reason for gains was that if we get a recession, the FRB will pivot strategy to stabilize the economy. There has been zero indication from a very transparent FRB that this would be the case. There is historical precedent to say the market is right, however, all of those precedents came during low inflationary periods. At this point, rather than looking for a pivot, markets should accept a stabilization of rates is most likely. This would be the case until we see substantial damage to the employment market. At which time, the FRB would likely pivot as enough damage would have been done to inflation.
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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.