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 Federal Reserve is trying to put the economy into ‘neutral’. What does it all mean for growth?
Monday S&P 500 0.81% | NASDAQ 1.90%
Ukraine regained territory in their war over the weekend. This improved sentiment early for markets. Elon Musk announced that he currently holds a 9% share of Twitter, which sent tech stocks higher.
Tuesday S&P 500 1.26% | NASDAQ 2.26%
ISM Services data came out strong at 58.3, but that did not deter a selloff in markets Tuesday. Federal Reserve Board (FRB) Governor Brainard made indication that ‘Quantitative Tightening’ could begin as early as May. This is earlier than markets are anticipating. This sent Bond and stock markets south. The ten-year treasury added .14% in yield on the day. If there was a silver lining, it would be that the 2/10 yield curve reverted back to a positive slope.
Wednesday S&P 500 0.97% | NASDAQ 2.22%
Markets opened lower and stayed there throughout the day. The anticipated FRB minutes from March were expected to show a hawkish FRB, sure enough they did. It is now expected that we will see a 0.50% hike in May. Additionally, FRB roll off of their balance sheet will likely begin.
Thursday S&P 500 0.43% | NASDAQ 0.06%
Market movements on Thursday were focused on a more aggressive FRB, given the minutes from Wednesday. Markets were up, but to be noted was that the leading stock sectors were defensive, i.e. staples and healthcare. Initial jobless claims fell to 166K for last week, which signals continued strength in the job market. This signal reinforces FRB action.
Friday S&P 500 0.27% | NASDAQ 1.34%
Growth stocks led lower on Friday as concerns swell regarding a potential recession as a result of an over-active FRB. We have time before a recession, but markets pricing growth stocks will not be fortunate in the run up.
Conclusion S&P 500 1.27% | NASDAQ 3.86%
Markets moved lower for the week as yield curve inversions and an aggressive FRB could bring us closer to recession. ‘Neutral’, where the FRB is neither tightening nor loosening monetary policy is perceived to be between 2% and 2.5%. We are currently sitting at 0.25%. If the FRB were to aggressively raise rates over the remainder of the year, then we could get to ‘neutral’. This means that we likely have 8 to 12 months before tighter monetary policy could lead to a recessionary environment.
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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.