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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Monday
Rotation, rotation, rotation. Markets fell Monday led by the NASDAQ. The gainers for the day were financials, commodities, and specifically energy. The move is indicative of rising inflationary expectations.
Tuesday
The start of trading on Tuesday looked much like Monday as markets opened deep in the red. Technology shares led the market lower once again. The move, however, did not last. The S&P 500 erased all of its losses for the day to end the day up 0.13%. The NASDAQ was not as lucky as it still fell 0.5%. This further advanced the value vs. growth trade.
Wednesday
Markets on Wednesday shrugged off the recent woes and steamed to a strong close. The S&P 500 rising 1.14% out pacing the NASDAQ at 0.99%. Much of this came following Federal Reserve Chair comments affirming loose monetary policy well into the next economic expansion.
Thursday
The day started bad and just kept getting worse. The S&P 500 tumbled 2.45% and the NASDAQ tumbled 3.52%. This was happening as interest rates continued to rise in anticipation of inflation later this year. This inflationary expectation is nothing new. The economy is improving quicker than expected and appears to be spooking the markets.
Friday
The S&P moved between positive and negative territory all day. Settling 0.48% lower. This was not much of a rebound statement after the tumble markets took Thursday. The reflation trade that calls for strong growth later this year is concerning in the credit markets. The burden that debt will have on corporate balance sheets as rates rise could cause concerning pressure on earnings.
Conclusion
Last week was a rough one for the markets. The S&P 500 lost 2.45% and the NASDAQ fell 4.92%. The losses last week reflect concerns that the economy will grow too fast. As consumption ramps up, inflation becomes more of a risk. That inflation will likely lead to a steeper yield curve causing adjustable-rate debt to increase interest obligations on corporate balance sheets. This increased debt obligation is feared to cut into corporate profits in the future. In this way too much growth can be a bad thing… Kind of…
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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.