Published September 6, 2024
Below, we offer a few takes on recent market moves and the outlook for the next couple of months.
With a volatile August and a swift decline to start September, investors are feeling uneasy.
The chart below shows that September is the worst month of the year and the only one with a negative average return.
Source: Freedom Capital Markets
And although the magnitude of the average decline improves during an election year, it’s still not positive, and October is often even worse!
Source: Freedom Capital Markets
The election cycle seasonality chart below gives us a good idea of where we are (in red) compared to the past. If history repeats (or at least rhymes), this analysis suggests the next two months could be rough for stock market bulls.
Source: Grant Hawkridge/All Star Charts
Even one of Wall Street’s biggest bulls, Tom Lee of Fundstrat Global Advisors, is calling for a 7-10% correction over the next eight weeks. With that said, he says it should be a buying opportunity and still expects his ‘40% rally in small-cap stocks by year-end’ thesis to play out.
But nonetheless, history and many of Wall Street’s most-followed analysts are painting a cautious picture for stocks through September and October. Time will tell if they’re right, but it seems nervous investors are selling first and asking questions later.
Seasonally poor performance
Below, we offer a few takes on recent market moves and the outlook for the next couple of months.
As for the interest rate backdrop, we are closing in on the Fed’s pivot to reducing short-term rates. The 10-year U.S. treasury rate at about 3.7% is near the 52-week low. This offers good and bad news. The good news is it suggests the bond market believes inflation is coming down and will eventually reach the Fed target rate of 2%. The bad news is it suggests U.S. economic growth may also be diminishing.
When the labor market provides a hint of recession, it appears the equity market is eager to sell-off. We have seen this phenomenon several times over the past several weeks.
This week, we learned that the ISM-Services index, reported to be 51.5%, came in higher than the previous month and above expectations. 70% of U.S. economic activity is driven by services. August showed a slight acceleration over July. Even with this good news, the S&P 500 traded lower on a weaker job openings (JOLTs) report.
The corporate debt market is signaling a soft landing/no recession. Defaults remain below their long-term trends. The high-yield debt market is near its most benign levels on record with 50% of the index BB-rated (top of the high-yield bond ratings hierarchy). Since 2022, about 20% of the high-yield corporate debt issuance was upgraded to investment-grade/high-grade. Typically, credit metrics deteriorate and margins compress in advance of a recession. Corporate profit margins are currently expanding.
On the consumer side, executives have highlighted a divergence in spending behavior across income brackets. While growth remains robust at the upper-end, lower-end consumers appear increasingly value conscious. They’re still spending but just allocating dollars in a more discerning method. This strong consumer spending has translated to strong corporate earnings.
At the same time, secular investment trends like AI, the energy transition, and onshoring should continue to boost capital expenditures. Balance sheets also remain robust, reducing the risk of something breaking.
Unlike typical late-cycle conditions, consumer spending has been financed by real wage growth rather than borrowing, and companies are still spending down the cash they accumulated during COVID.
In the wake of recent volatility, investors should anchor to the fundamental truth highlighted this earnings season: consumer and corporate spending is moderating but looks durable, so economic growth should be too.
Source: Fundstrat, Winfield Smart, MarketWatch, U.S. Bank
Market Update
Ah September. The notorious month for the stock market. Many mutual funds wind down their fiscal years, choose which positions, if any, to take profits or losses on, and generally get things set for their year-end. Plus, we have had some sharp drops in the August-October timeframe, historically. Investors know this history and often become on edge. This year seems perhaps a bit worse in terms of nervousness as we approach an inflection point for the Federal Reserve. The central bank looks all but locked in to their first cut in short-term interest rates later this month. Whether that will be a small 0.25% cut or a larger 0.50% cut is the debate of the moment with investors parsing every economic report for clues. A 0.50% cut is perhaps warranted if we are only looking at inflation reports, which have been trending down all year and have essentially reached The Fed’s targeted level. However, recently, investors have shifted toward a focus on possibly softening economic data. Is the economy losing so much steam that the central bank will feel compelled to step on the gas a bit with the larger cut? And if that’s the case, what impact would a softer economy have on corporate profits, which have heretofore been steady and strong – and a huge support for rising stock prices.
Coming back from Labor Day and summer break, stocks sold off Tuesday. Worries about a weakening economic picture sent the Nasdaq down -3%. A couple of flat days Wednesday and Thursday as investors awaited the monthly jobs report, an economic reading that, this time, seems to carry more weight given the Fed’s imminent rate cut decision. Friday brought the report and it was seemingly ok – with a touch more hiring than June and July (which were revised lower) but only modestly so. The unemployment rate ticked down, but only from 4.3% to 4.2%. In short, the jobs report wasn’t bad enough for investors to clearly expect a larger -0.5% cut from the Fed. So, stocks sold off again. The S&P 500 slid -1.7%.
For the week, stocks fell back from their near-record highs as fears of a slowing economy held court now that earnings reports are largely done. The S&P 500 suffered its worst week since April falling -4.14%. The Nasdaq 100 (QQQ) tumbled -5.79%. Small-cap stocks, which had been on a tear with interest rates coming down, slid back a hefty -5.53%. The 10-year Treasury rate fell back to its August lows at 3.7%, well down from the 5.0% it hit a year ago.
Warm wishes and until next week.