What happened in the markets - 11-15 Sep 2023

Introduction

Last week, the spotlight was on technology, with the markets swaying to the rhythm of new tech advancements. U.S. equities held their ground, thanks to AI, while Chinese electric vehicle (EV) brands gave European automakers a run for their money. Some Research Weekly experts are on the case, dissecting the details and forecasting the potential for a European recession.

The major equity indexes had a mixed performance, with value stocks taking the lead as U.S. benchmark West Texas Intermediate oil prices climbed above $90 per barrel for the first time since November 2022. Large-cap shares outshone small-caps.

🔬 Tech stocks - AI was the star of the show this week, bolstering U.S. equities amidst market fluctuations. Meanwhile, Chinese EV brands revved up the competition against European automakers, signalling a shift in the automotive industry.

🛢️ Energy stocks - The price of West Texas Intermediate oil, the U.S. oil benchmark, broke above $90 per barrel, a level not seen since November 2022. This surge gave a boost to value stocks, leading the market.

📊 Large-cap vs Small-cap - Large-cap shares outperformed small-caps this week, demonstrating the resilience of established companies amidst market volatility.

Why is this important? The performance of tech stocks, particularly in AI and EVs, indicates the growing influence of technology in the market. The rise in oil prices and the performance of large-cap shares also provide valuable insights into market trends and potential investment opportunities.

Fun fact: Did you know that the performance of large-cap shares often reflects investor confidence in the market? When large-cap shares outperform, it typically indicates a bullish market sentiment.

Key Takeaways

Energy prices are going up and it's affecting how much people are spending. The main Consumer Price Index (CPI) went up in August, but the core CPI went down a bit more.
People are still spending money, but the growth is slowing down. This is because they've been using up all the extra money they've saved over the last three years.
The Federal Reserve (the Fed) wants to slow down how fast they're raising interest rates. They're going to ignore the higher energy costs for now and keep the rates the same this week, but they're still staying alert.

How big of a threat are rising oil prices?

WTI crude oil prices have been on a rollercoaster ride this year. After averaging around $75 for most of the year, they hit a 10-month high last week, reaching about $90 a barrel. However, they're still a long way off from last year's peak of $123.

The recent surge in oil prices can be attributed to production cuts from Saudi Arabia and Russia. Both countries, major players in the oil market, announced earlier this month that they would maintain their current reduced production levels until the end of the year.

Interestingly, consumers today are less sensitive to energy prices than they were in the past. In the 1970s, energy spending accounted for around 9% of overall personal consumption expenditures. Today, it's down to 4%. While higher energy prices generally act as a tax on consumers, leaving them with less money to spend on other things, they can also help keep core inflation in check by potentially leading to reduced demand for some services.

Unlike last year's spike in oil prices following the invasion of Ukraine, natural gas prices have remained near their three-year lows, providing some relief for utility costs.

Looking at the global demand perspective, sluggish growth in China, the world's biggest oil consumer, and a slowdown in European activity could prevent oil prices from rising past the $100 mark. On the domestic front, U.S. consumers have been spending at an elevated pace, but as we move past the summer travel season, demand for travel and other services is likely to moderate. In a nutshell, while oil supply is being restricted until the end of the year, the demand picture isn't overly supportive. This should put a cap on how high oil prices might rise.

Oil prices rose to 10-month highs but natural gas prices have not followed

Economic Data Lift Hopes for Soft Landing

Let's dive into the recently released August consumer price index (CPI) data and its implications on the Federal Reserve's ongoing battle against inflation.

💸 What does the August CPI data reveal?

The headline CPI numbers for August showed the largest monthly increase since August 2022, primarily driven by higher gasoline prices. This was largely expected. The core CPI (excluding food and energy) increase was slightly above expectations, but the markets seemed to take this news in stride.

💸 What about the Producer Price Index (PPI) data?

The August PPI data, released on Thursday, indicated that headline producer prices climbed more than anticipated, with core PPI aligning with expectations.

💸 How did retail sales fare in August?

Retail sales for August were robust, indicating that consumers are still willing to spend despite the inflationary pressures.

💸 What's the market's outlook for the Fed's next move?

The economic data released this week didn't seem to significantly alter the market's expectation for the Fed to maintain rates at its September 19–20 policy meeting. Much of the data seemed to reinforce the growing expectations for a "soft landing" scenario, where inflation cools down to the Fed's target without triggering a deep recession.

💸 What's the sentiment on Wall Street?

Interestingly, Wall Street's widely followed "fear gauge," the Chicago Board Options Exchange Volatility Index, or VIX, hit its lowest point since before the pandemic began in early 2020. This suggests a level of market confidence in the Fed's handling of inflation.

Consumer spending is normalising after the post-pandemic surge

Year-over-year change in retail sales, control group

Fed wants to downshift, but incoming data are in the driver's seat

The Fed's View on Inflation: Despite the mixed inflation report from last week, analysts believe that the narrative for Fed policy remains unchanged. The reaction in bond yields confirms this. Fed officials are keen on slowing down the pace of rate hikes and are likely to overlook the higher energy costs for now, keeping rates steady at this week's meeting.

However, policymakers are committed to bringing inflation down to target. With a strong emphasis on data-dependency, any potential bumps to the disinflation trend could keep the possibility of a Fed rate hike later this year on the table.

Market Expectations: Bond markets are currently not expecting a Fed rate hike next week, and there's only about a 30% chance of one last hike in November. They also predict one percentage point of rate cuts by the end of 2024. Analysts believe that conditions will align for the Fed to implement rate cuts next year, but the timing and number of cuts remain uncertain.

The Economy's Response: The economy seems to be responding to the Fed's tightening measures, which are designed to curb inflation. While some analysts predict a slowdown in growth in the upcoming quarters, the path for a soft landing has broadened, potentially avoiding a traditional recession. The expectation now is for a rolling downturn, with sectors like manufacturing and housing stabilizing, while service sectors may soften.

The Stock Market's Reaction: The recent underperformance of small-cap stocks, which have fallen below their large-cap peers' 2020 low, serves as a warning that risks persist. However, the foundation for a sustained uptrend in stocks might already be in place, as earnings estimates seem to have bottomed out and recently surpassed last year's peak.

What This Means for Investors: The transition to lower growth, inflation, and Fed policy is rarely smooth. Investors should set realistic expectations for returns and volatility. We haven't seen a 10% correction so far in 2023, which typically happens once per year on average. So, don't be surprised if a deeper pullback occurs in the historically weaker months of September and October. But if it does happen, analysts would view it as an opportunity. They don't see any major economic or financial imbalances, and rates are likely near their peak for this cycle.

Number of market implied hikes/cuts

Stocks on the move

The following companies experienced changes in their stock prices due to their quarterly earnings, analyst ratings, or other news:

Adobe (ADBE) saw a 4.5% decrease in share prices as its sales seemed to disappoint investors. The software company's higher-than-expected quarterly results failed to impress.
DoorDash (DASH) saw a 2.6% decrease in share prices after research firm MoffettNathanson downgraded the food delivery company to "market perform" from "outperform," saying the resumption of student loan payments could hurt demand.
General Motors (GM) saw a 0.7% increase in share prices and Stellantis (STLA) rose more than 2%, suggesting investors aren't too concerned about the United Auto Workers strike that began Thursday night. Ford Motor Co. (F) saw little change in share prices.
KeyCorp (KEY) saw a 0.7% increase in share prices after Piper Sandler upgraded the stock to "overweight" from "neutral," saying the regional bank's funding issues are "beginning to move to the rear-view."
Lennar Corp. (LEN) saw a 2% decrease in share prices after reporting that rising interest rates had eaten into its margins. The homebuilder also reported stronger-than-expected quarterly results.
Nucor (NUE) saw a 6% decrease in share prices after the steelmaker's third-quarter earnings forecast disappointed investors. The company cited weaker pricing and volumes.
Unity Software (U) saw a 1.4% increase in share prices after a Bank of America analyst upgraded the stock to "buy" from "neutral," citing the company's "industry leading" mobile game-creation engine.

The start of the third-quarter earnings season is still about a month away, but next week will feature a few major companies reporting results from the previous quarter. Those include FedEx (FDX) and General Mills (GIS) on Wednesday.

What to Expect in the Markets This Week

Federal Reserve policymakers are gathering for the latest FOMC meeting on Tuesday, with an interest rate decision expected on Wednesday. This decision could have significant implications for both the stock and bond markets, so it's definitely something to keep an eye on.

On Friday, investors will also get a first look at S&P Global's September Purchasing Managers' Indexes (PMs) for manufacturing and services.

We'll also be getting the latest updates on the U.S. housing market. This includes data on building permits, housing starts, and existing home sales for August. These figures can give us a good indication of the health of the U.S. economy and the strength of the consumer. In addition, we'll be getting the NAHB's Housing Market Index for September. This index measures sentiment in the U.S. housing market and can be a good leading indicator of future housing market activity.

The docket includes the second quarter's current account balance, July international capital flows, and September business surveys from the Philadelphia and New York Fed Districts. The U.S. Treasury Department will issue $28 billion in 10- and 20-year securities in the auction space.

Investors will also focus on the Bank of Japan and its policy meeting late in the week, the country's preliminary PMs for September manufacturing and services, and August's national CPI, PPI, and trade balance. Updates on Australia's August Leading Index and September PMs, along with South Korea's August PPI, will also be available.

In Europe, the focus will be on the first release of September eurozone MIs for manufacturing and services. Across the pond, the Bank of England (BoE) will hold its own policy meeting on Thursday. The BoE's decisions can have a major impact on UK stocks and the global financial market.

Additionally, the finalised eurozone CPI for August, September consumer confidence for the eurozone and the U.K., August French retail sales, and German PPI are due. On Tuesday, the Organisation for Economic Co-operation and Development (OECD) will release its Interim Economic Outlook for the world economy and G20 countries.

Scheduled economic releases for week of September 17, 2023.