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 on hopes of an infrastructure compromise. What does it mean for markets and inflation as we look ahead?
Monday
The new week brought optimism. So much so that the markets rebounded more than half the losses from the prior week in one day. All eyes are to Washington, however as Federal Reserve Board (FRB) Chair Powell is set to testify.
Tuesday
FRB Chair Powell’s testimony about inflation rising higher than expected did not sully the mood of markets. The S&P 500 still rose 0.51% on the day. While he acknowledged it rose more than they expected, they won’t be making any rash decisions about increasing rates early.
Wednesday
Markets were fairly unchanged for the day. The S&P 500 fell 7.44 points (0.18%). The new home market continued to cool as purchases fell by 5.9% (May). While construction costs have increased approximately 10% over the last year, new home prices have risen 17%.
Thursday
The market activity was bullish on Thursday with all major indices higher. This move was a forward-looking move as durable goods orders and new unemployment claims missed estimates. An infrastructure deal was agreed upon in principle which brought optimism on spending.
Friday
Consumer sentiment missed estimates. It was expected to rise to 86.4 and came in at 85.5 (June). The softer sentiment could lead to weaker than expected retail spending. It’s becoming more likely that second quarter GDP estimates will miss expectations.
Conclusion
Markets surged back this last week. Not on economic data, as that was weak, but rather the hope brought about from an infrastructure package. If delivered, it should alleviate some of the jobless rate issues plaguing the new expansion. However, it will likely exacerbate some supply line constraints. This will calm some overall inflation concerns while leaving material prices elevated for some time.
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