What happened in the markets - 18-22 Sep 2023

Introduction

It's been a tough week for the U.S. Stock Market. The major U.S. equity benchmarks took a hit as investors reacted to the Federal Reserve's hawkish forecasts and rising U.S. Treasury yields. The S&P 500 Index experienced its largest one-day loss in six months on Thursday, marking its third consecutive losing week. Ouch! There's more than just concerns about higher interest rates at play here. Many traders have pointed out that worries about the impact of the United Auto Workers' strike and the potential for a U.S. government shutdown may have also put pressure on the markets. To add to the mix, some investors are approaching their fiscal year-end, which could have amplified the selling due to tax-loss harvesting.

Key Takeaways

Most central banks are done hiking rates, with a few left to deliver their final hike.
The market was quick to react to this somewhat hawkish Fed outlook. Treasury yields moved sharply higher, as both the 2-year (which is more sensitive to moves in the fed funds rate) and 10-year yields moved to highs of this cycle, putting downward pressure on stock and bond returns. Longer-duration parts of the market, including technology and growth sectors, underperformed the broader market.
Inflation appears to be contained, and oil price spikes may be short-lived with demand stagnant and production picking up.

Fed surprises with higher-for-longer forecast

As we wrap up the week, let's dive into the recent Federal Reserve meeting and its implications on the market.

📈 Fed's Rate Outlook Surprises Market

In a move that caught the market off guard, the Fed maintained its short-term lending benchmark at a target range of 5.25% to 5.50%, consistent with the level set at the previous meeting in July. However, the real surprise came with the Fed's updated Summary of Economic Predictions, which projected a higher-than-expected rate for 2024 and an increased rate prediction for 2025.In addition, the central bank upgraded its growth forecast, acknowledging that the economy has shown more resilience than initially anticipated.

The Sept “Dot Plot” shifted upwards, implying rates would stay higher for longer. *Source: FOMC, September 2023.*

📉 A Quiet Week for Economic News

Aside from the Fed meeting, it was a relatively calm week in terms of economic news. The weekly initial jobless claims came in lower than expected, dropping to the lowest level since January. This further strengthens the perception that the labor market remains robust.

📊 Market's Expectations from the Fed

The market was banking on the Fed to reiterate its commitment to tackling inflation, and keeping an additional rate hike on the table was an effective way to communicate this. Post the meeting, the market now anticipates the Fed to maintain its current stance, although the likelihood of a December hike has seen a slight uptick.The first rate cut is now expected in July 2024, a delay from the June rate cut that was priced in before the meeting.

Markets have pushed back their expectations for the first Fed rate cut, from June to July 2024. *Source: CME FedWatch*

🔮 The Fed's Next Move

Many analysts believe that the Fed's next move will largely depend on the economy's trajectory. While it now forecasts stronger growth in 2023 and 2024, a weakening consumer or broader economy could prompt the Fed to cut rates earlier or by more than the projected 50 basis points next year. However, if growth remains steady and inflation continues to ease gradually, the market's current view seems credible. In this scenario, we can expect the Fed to gradually normalize rates down towards a neutral level over time.

Stocks falls on Fed’s hawkish pause, meanwhile U.S. Treasury yields reach multiyear highs

This week, stocks are on a downward trajectory, thanks to some hawkish commentary from the Federal Reserve and a pause in rate hikes. However, the Federal Open Market Committee members are hinting at one more interest rate hike before the year ends. 📈

On the economic front, the housing market is still struggling with limited supply and high mortgage rates. Next week, we'll be keeping an eye on updates on personal income, personal spending, and personal consumption expenditures - the Fed's favorite inflation indicator. Plus, we'll be focusing on the housing market with new data on new and pending home sales.

Real estate remains at weak levels. *Source: Julius Bar*

The Fed's plan to keep short-term rates higher for longer, coupled with healthy economic growth signals, has pushed longer-term U.S. Treasury yields to a 16-year high. Meanwhile, yields on AAA rated municipal bonds have also shot up as investors brace for a higher rate regime.📊 In the corporate bond market, yield premiums relative to Treasuries have remained relatively stable despite the equity market's risk-off environment. The high yield bond market is buzzing with activity, with more deals expected due to strong demand for new issues.

US 10-year and 2-year treasury yields reach a high for this cycle, adding downward pressure to stocks and bonds. *Source: Bloomberg.*

For equities, the higher yields come at a time of concern around extended valuations, particularly in the large-cap tech space and among the "Magnificent 7" (AAPL, AMZN, GOOGL, META, MSFT, NVDA, TSLA). These stocks initially soared due to excitement around artificial intelligence, but now face the challenge of a higher-rate environment. 📉 Adding to the market's worries are the potential government shutdown and ongoing UAW strikes, which could create near-term uncertainty. As we navigate through the typically volatile months of September and October, we might see some consolidation and profit-taking in stock markets. However, we don't expect a pullback to extend beyond a normal correction. 📉

Valuations more reasonable outside of large-cap technology (Fwd P/E ratio). *Source: Bloomberg. Magnificent 7 stocks include AAPL, AMZN, GOOGL, META, MSFT, NVDA & TSLA.*

Stocks on the move

Let's dive into the stock movements driven by quarterly earnings, analyst ratings, and other news. Here's the scoop!

Activision Blizzard (ATVI) saw a 1.7% uptick following reports that Microsoft's (MSFT) restructured acquisition deal had addressed antitrust concerns raised by U.K. regulators. However, Microsoft's stock dipped by 0.7%.
Deere (DE) took a 1.2% hit after Canaccord Genuity downgraded the farm and agricultural equipment maker's stock from "buy" to "hold," citing slower growth for tractor and other agricultural equipment sales.
Costco Wholesale (COST) enjoyed a 0.6% rise after HSBC initiated coverage of the retailer with a "hold" rating and a $600 price target, which is about 7% above current levels. HSBC believes the U.S. retail market is set for further growth.
Ford (F) shares revved up by more than 2% following a CNBC report that the automaker was making progress in negotiations with the United Auto Workers union amid an ongoing strike. Other auto stocks showed mixed performance, General Motors (GM) shares slightly down.
Snap. Inc. (SNAP) rose about 1.5% after Bloomberg reported that the messaging service had gained more than 5 million subscribers for its subscription product, Snapchat+.
Squarespace (SQSP) saw a rise of more than 4% after UBS initiated coverage of the stock with a "buy" rating, citing the company's solid product suite and growing brand awareness.

Opportunities in the new higher-for-longer world

As we navigate through this new "higher for longer" regime, it's crucial to understand how to strategically position our portfolios. While higher rates can exert pressure on certain segments of the stock and bond market, they can also unlock opportunities for sectors that thrive on higher yields. Let's break it down!

Equities: We anticipate a shift in leadership as rates remain elevated. It might be a good idea to balance your portfolio by complementing growth and technology sectors with areas of the market that offer more attractive valuations. Over time, cyclical sectors like industrials and materials, and even small-cap and international stocks, may start to catch up.
Bonds: While short-duration cash-like instruments yielding over 5.0% may seem appealing, we advise caution against being too overweight in cash. There's a risk of reinvestment as the Fed eventually pivots lower, and we see more enticing opportunities in the longer-duration investment-grade bond space. Historically, current yields have been one of the best predictors of forward returns. If the Fed is hinting at nearing a peak interest rate, this could be an opportune time to invest in high-quality bonds. Not only can you secure better rates for a longer period, but you also stand a chance for price appreciation if and when the Fed pivots lower.

We're gearing up for a busy week in the financial markets, with a slew of economic updates and reports on the horizon. Here's what to keep an eye on:

In the US, we're expecting August updates on personal spending and income, along with the PCE Deflator. We'll also get a third reading of the second quarter Gross Domestic Product (GDP) growth, August's durable goods orders, advance goods trade balance and wholesale inventories, and September's consumer confidence and Chicago PMI.
The housing market will also be in focus, with data on August's new and pending home sales and dual measures of July home prices. We'll also see finalized September University of Michigan consumer sentiment, along with various updates on business activity from regional Fed banks.
Over in Asia, investors will be closely watching Chinese September PMIs for manufacturing and services from both the China Federation of Logistics & Purchasing and from Caixin. Japan's releases include Tankan Indexes for the third quarter, September's Tokyo Consumer Price Index (CPI) and finalized manufacturing PMI, and August's jobless rate, industrial production, and retail sales.
We'll also get updates on Australian retail sales and inflation, as well as South Korea's trade balance, manufacturing PMI, and manufacturing and non-manufacturing business surveys. In Europe, the focus will be on September's preliminary eurozone CPI, finalized consumer confidence, and August's money supply. German releases include September's CPI, unemployment change, and business sentiment survey, along with August's retail sales and prospects for consumer confidence for October.
We'll also see the French September CPI and consumer confidence reports, along with August's Producer Price Index. From the U.K., we're expecting finalized second-quarter GDP growth and an update on September home prices. All these data points can cause significant fluctuations in the markets, so keep your eyes peeled and your investing strategy flexible.