09|27|2022

Hope on the Horizon? | September 23, 2022

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:

  1. 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.
  2. 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 bears are firmly in control right now. Should it last or is there hope on the horizon?

Monday   S&P 500 0.69% | NASDAQ 0.76%

The start of the week was a trading day of uncertainty. Markets ebbed and flowed, finally finding a footing late in the day. Markets ended up rising but not in a convincing fashion given last week’s sell-off. Anticipation is building towards Wednesday’s Federal Reserve Board Press conference.

Tuesday   S&P 500 1.13% | NASDAQ 0.95%

Markets opened in the red and stayed in the red all day. The economic data on the day was positive which of course led to a negative market. Housing starts rose by 12% in August. More robust new home data actually signals a stronger buyer than was expected. The concern reinforces the idea that the FRB has to go further than they already have to create demand destruction.

Wednesday   S&P 500 1.71% | NASDAQ 1.79%

The FRB delivered a 0.75% rate increase. They have two meetings left for the year and they anticipate 0.75% in November and 0.50% in December. The unemployment and inflation data would have to soften substantially for a milder move.

Thursday   S&P 500 0.84% | NASDAQ 1.37%

Markets continued their retreat post the FRB rate hike on Wednesday. Interest rates continued to climb in anticipation of 4.5% by year end. Interest rates and prices move in opposite directions.

Friday   S&P 500 1.72% | NASDAQ 1.80%

The fall on Friday was worse than its headline number represents.  The S&P closed at 3,693.23, however it reached a low of 3,649.16. This is a break of the support level of 3,666.77, which was the close on June 16th. The fact that markets did not stay below support into the close is not necessarily encouraging. It will likely be surpassed within the next few trading sessions.

Conclusion   S&P 500 4.65% | NASDAQ 5.07%

We have been told that this is not a recession given the strength of the consumer. The FRB delivered another blow on Wednesday to the consumer by raising rates to 3.25%, moving into restrictive territory. The move should help to quell demand, but it is not the last. 1.25% is still expected before year end, bringing us to 4.5%. The market’s behavior is telling us that if we are not in a recession, that we will be soon. Our current recessionary behavior is specifically not the depth with which markets have fallen; rather, the bear market rally with a retest of prior lows following. This is a behavior that is typical of recessionary environments. This means that we should see several bear market rallies along the way. It could come from corporate earnings, political transitions in November, or even the vaunted Santa Claus rally. Look for growth, but with subsequent pull backs.

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Your interest in our articles helps us reach more people.  To show your appreciation for this post, please “like” the article on one of the links below:

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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.