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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Is Santa’s rally coming, or will Omicron steal the show? Most importantly, what does it all mean for 2022?
Monday
The week opened in free fall as the Nasdaq led the way lower. Omicron news and the Build Back Better plan getting nixed seemed to sour investors to open the week. Haven stocks did not gain interest in leu of an equity sell off. This came as a result of the anticipated Federal Reserve Board (FRB) rate increases in 2022.
Tuesday
Markets spiked up on Tuesday. It was strongly seen as investors deciding to ‘buy the dip’. There has been a 3% pullback over the last few sessions. The S&P 500 gained 1.78% on the day.
Wednesday
‘Buy the dip’ continued on Wednesday. One clear distinction from a normal ‘buy the dip’ is that volumes are definitely holiday lite. That means that very little can be made of the current rally. The S&P 500 ended up gaining 1.01%.
Thursday
In a holiday shortened trading week, markets climbed to close the week. A word of caution would be that trading volume has been extremely light! It has been running 25% of that of a normal trading day. Not surprising, but cause for caution that this buy spree may not be well founded.
Friday
Merry Christmas! Don’t shoot your eye out!
Conclusion
The week started with an echo of last week’s trading weakness. It very quickly shifted to perhaps the beginning of a Santa Claus rally. Historically, this occurs the week between Christmas and New Year’s. Again, on light trading volume. This could lead to a strong year end but could be of concern for a pullback in January. Also, given past circumstances, the US will likely be in the thick of the Omicron variant come January.
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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.