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 S&P 500 shed 1.94% on the week as Omicron took center stage. Will Omicron steal Santa’s Thunder?
Monday
Markets opened the week in the red. This came as the first true negative news broke on Omicron over the weekend. There are now studies showing that second dose treatments of MRNA vaccines are not very effective on Omicron. Additionally, the UK announced their first fatality of an Omicron infected individual.
Tuesday
Inflation, inflation, inflation… Omicron, omicron, omicron… Markets dove on Tuesday as the Producer Price Index rose more than expected. The fear being that companies will have to pass those price increases through to consumers or realize weaker profits. Either scenario is bad. Omicron continues to make noise as its high transmission rate is leading to spikes in cases.
Wednesday
Market movement early was very minimal. Most investors seemed to be awaiting the results of the FRB meeting. The FRB did not disappoint. They will accelerate their taper program from $15B/month to $30B. They also signaled the potential for as many as 3 hikes in 2022. This data should prompt a negative market response, however, the markets climbed in response. The S&P 500 ended up adding 1.63% on the day. So why the gain? Investors likely view the increased action from the FRB as being in line with market expectations given current conditions. By accelerating their process, they avoid a potential misstep of being too dovish and letting inflation run away from them.
Thursday
Re-opening stocks did well on the day, but the markets as a whole fell back from the surge on Wednesday. The Nasdaq lagged the S&P 500, which is logical since it has been leading on the up days as well. The S&P 500 ended up losing 0.88% on the day. The Nasdaq dropped 2.47%. The moves on the market seem to be the long response to the FRB move yesterday. The actions of the FRB would lead towards leaner demand and softer profits on the year.
Friday
Markets tumbled on Friday while there was no major economic data on the day. The void left by economic data pushed the focus to headlines surrounding Omicron. The S&P 500 ended up falling 1.07% to close out Friday. The week saw the S&P 500 tumble 1.94%!
Conclusion
One of the fears of an overly aggressive FRB is taking action before the job market can fully mature. Participation is an important factor to the term “full” employment. In 2007, participation in the labor market was running at 66% of the population. After the 2007 recession, the rate continuously fell until 2013. The workforce contraction had much to do with the boomer generation retiring. From 2013 to 2020, the participation rate held steady at 63%. This was a combination of boomers holding off retirement and an influx of the millennial generation into the work force. During the pandemic, the rate fell to 60.8% and has since bounced back to 61.8%. So, the big question is, “Where is that other 1.2%?” If we start attacking inflation before they comeback, will we stem job growth and prevent full employment? No. They are not coming back. With every recession, you’ll find workers who decide that retirement chose them rather than the other way around. As a result, there is very little fear that the FRB’s actions are moving too quick, but rather too slow.
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