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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There was a little run up on markets from a point total standpoint, but volatility was way up. What does it mean?
Monday
Happy 4th of July!
Tuesday
Markets dove on Tuesday to open the week. The S&P was down nearly 1% by mid-day but came back to end the day down 0.2%. The Delta variant took center stage as concerns are mounting that it could derail the re-opening trade currently in place.
Wednesday
The S&P 500 reached fresh all-time highs. The improved investor sentiment was on the release of Federal Reserve Board (FRB) minutes. They reflected a dovish FRB heading into the second half of 2021. The interesting thing was that interest rates in the treasury market were down. So, while there was a bid in the equity markets, there was not a sell off in bonds. This makes the rally more conservative.
Thursday
Broadly all major indices were down on Thursday. This came as the Delta variant surpassed the Alpha variant as the dominant COVID strain in the US. Continued stress over the variants will likely keep markets from climbing unfettered.
Friday
Markets surged back on Friday and ended in the green for the day (and the week). Yields increased mildly as gold and oil both surged, which are both bullish and bearish at the same time. The increase on a Friday again is a good sign that little negativity is expected across the weekend news cycle.
Conclusion
The S&P 500 rose a meager 17 points for the week. The point line, however, is deceptive as it was a volatile week. The CBOE VIX (Volatility measure) increased from 14.5 to 17.5 as the daily swings were in excess of those in the prior week. The coming week will have economic data in the form of retail sales and industrial production. The variant progress will continue to be watched as well. Additionally, GDP for China will be reported giving further indication to US consumption via Chinese exports. Increased volatility is not surprising as we move into summer months. The reduced volume is the result of summer vacations. With lower volume comes increased volatility. Increased volatility does not necessarily come with losses, it just means the swings are more violent.
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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.