Is the Rally Over? | August 19, 2022 | FFS

Chaos on the red sofa after new year party

TITLE: INVESTMENT ADVISER REPRESENTATIVE

TAGS: S&P 500, NASDAQ, Yield Curve, FRB, Rates, Nvidia

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 5^th, 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 rally is over, or is it? Markets fell last week, but should we expect it to continue?

Monday S&P 500 0.40% | NASDAQ 0.62%

China lowered keys rates over night which yielded a bullish market at open. Heavy stimulus from China could signal a resurgence of activity later this year. This week will be heavy on consumer retail earnings.

Tuesday S&P 500 0.18% | NASDAQ 0.20%

Markets started the day in the red and floated into the green as the day progressed. Earnings out of Walmart beat expectations. Consumers are shifting their spend but still spending. They reported that the recent relief in fuel expenses has translated to consumer spending.

Wednesday S&P 500 0.72% | NASDAQ 1.25%

Energy prices increased on the day, raising concerns about future inflation. US exports of fuel increased last month as the US begins to replace Russian fuel supplies to Europe. Target failed to meet earnings expectations as inventories dragged on their performance. Federal Reserve Board (FRB) minutes from their last meeting were released. They showed an indication of slowing rate hikes ahead. Markets rebounded briefly on the news. Markets remained in the red throughout the day and ended there.

Thursday S&P 500 0.23% | NASDAQ 0.21%

Markets moved sideways most of the day trying to find a reason to rise. They did so in the final hour, but not by much. Short term interest rates floated down on the day and interest rate expectations softened. Oil prices firmed on the day, which will provide a contradictory opinion in coming days.

Friday S&P 500 1.29% | NASDAQ 2.01%

The equity markets retreated on Friday as anticipation builds towards the FRB’s meeting in Jackson Hole next week. As a result, the markets saw equities selloff, yields climb, a stronger dollar, and higher fuel-based commodities.

Conclusion S&P 500 1.21% | NASDAQ 2.62%

Welp, it was fun while it lasted, but the four-week rally seems to have lost steam. Markets closed the week in negative territory for the first time in five weeks. Eyes seem to be turning to Jackson Hole. The anticipation of a hawkish FRB will likely be fulfilled. As the economy continues to weaken with the current FRB activity, their resolve to stay hawkish will be tested. In the short run this could mean negativity, but in the intermediate term it should mean opportunity.