What happened in the markets - 25-29 Sep 2023

Introduction

The past week has been a rollercoaster for the U.S. Stock Market. Rising oil prices have stoked concerns about stubborn inflation, leading to a sell-off in bonds. As the week progressed, the looming threat of a U.S. government shutdown added to the market's jitters. The yield on the benchmark 10-year U.S. Treasury note even hit a peak above 4.6% on Wednesday. Remember, bond prices and yields move in opposite directions. However, the release of promising inflation data from both the eurozone and the U.S. led to a slight dip in 10-year Treasury yields. Tax-exempt municipal bonds and high yield bonds weren't spared from the selling pressure either.

The S&P 500 Index experienced its fourth consecutive weekly decline, with the rising rates seemingly dampening investor sentiment. Within the index, utilities bore the brunt of the losses. On the flip side, energy stocks outperformed their counterparts. The S&P MidCap 400 Index and the small-cap Russell 2000 Index, which have significantly trailed large-caps this year, managed to scrape out gains.

Why is this important? The market's reaction to higher oil prices and the potential government shutdown underscores the sensitivity of investors to inflation and fiscal uncertainty. As we navigate these turbulent times, it's crucial to stay informed and make investment decisions that align with your financial goals. Stay tuned for more updates!

Key Takeaways

Rising rates have weighed on stock returns, but peaks in 10-year yields have been a catalyst for stock-market rallies.
The fourth quarter has historically seen positive returns, particularly after a third-quarter decline.
Despite the market pullback, volatility has remained below previous sell-offs. The further decline in the PCE inflation measure last month is a favorable sign.

A peak in rates would present a catalyst for stocks to rally.

The recent surge in interest rates has been making waves across financial markets. This is primarily due to a shift in expectations for the Federal Reserve's upcoming policy, with market sentiment taking a hit as the Fed hints at maintaining restrictive monetary-policy settings longer than investors initially anticipated.

Analysts' Take on the Fed's Stance Analysts have long believed that the Fed would tread carefully when it comes to curbing inflation. The message that the policy rate may stay higher for longer doesn't come as a surprise. However, analysts are not entirely convinced that the Fed will need to tighten much more at this stage. They believe that time, rather than further rate hikes, is needed for inflation to moderate back towards the target. In other words, the Fed's stance may be more bark than bite from here. Regardless, this bark has driven rates higher and stocks lower, a reaction that could potentially create an opportunity.

The 10-Year Treasury Yield's Leap Last week, the 10-year Treasury yield soared above 4.6%, its highest since 2007. After a decade and a half of ultra-low interest rates, this has understandably caused some discomfort. However, we've seen these episodes of surging rates act as catalysts for stock-market rallies over the last year and a half. Previous peaks in the 10-year yield in June and October of last year, as well as March of this year, were followed by healthy gains in equities in the following months.

A More Favorable Inflation Backdrop Importantly, the inflation backdrop is notably more favorable this time around. Last year's rising-rate phases occurred as inflation was rising. Today, inflation is on a sustainable (though probably not perfectly smooth) downtrend. Admittedly, longer-term yields have risen higher than analysts anticipated. But with consumer price pressures moderating and the Fed's tightening campaign nearing its end, some analysts believe there's a case to be made that rates are close to their peak for this cycle. Thus, if inflation continues to fall and economic momentum softens in the coming months as expected, then a drop back in rates could set the stage for a year-end rebound.

Interest rates vs. the stock market

*Source: FactSet, S&P 500 Index and 10-year U.S. Treasury Yield.*

September was a tough month for the stock market, to say the least. The S&P 500 took a nearly 5% hit! Rising interest rates and worries that a tighter Federal Reserve policy might undermine the economy led to further weakness in growth and small-cap investments. The Nasdaq and Russell 2000 indexes didn't fare any better, both dropping close to 6% for the month.This resulted in a 3% drop for the S&P 500 for the third quarter, marking the first quarterly loss in a year. Ouch!Why is this important? The stock market's performance is often seen as a barometer of the economy's health. The recent downturn could be a sign of investor concern about the future of the economy, especially in light of potential changes in Federal Reserve policy.

Stock market performance during the month of September

*Source: Bloomberg, September price performance of the S&P 500 Index.*

If we take a look back at the history of the stock market, we might find some reasons to be optimistic about the coming months! Historically, weak third quarters have often been followed by a strong encore performance in the fourth quarter. Since 1990, in the 11 years when stocks fell in the third quarter, the S&P 500 rebounded with a gain in the subsequent fourth quarter nine times. That's an impressive average return of 10.6% in the final three months of the year! Small-cap stocks did even better in those years, averaging an 11.4% gain for the final quarter. Now that's something to cheer about! However, it's worth noting that 2000 and 2008 were the two instances in which the market fell in both the third and fourth quarters. So, while history can provide some guidance, it's not a guaranteed predictor of future performance.

Historically, the fourth quarter has been a strong period for stocks, with an average quarterly increase of 5% dating back to 1990. The last time we saw a dip in the final quarter was in 2018. However, the tide turned from 2019 to 2022, with an impressive average fourth-quarter gain of 9.5%. So, what does this mean for investors? Well, despite occasional third-quarter declines, the fourth quarter often brings a rebound, making it a potentially profitable period for those in the stock market. But as always, past performance is not a guarantee of future results, so keep your eyes peeled and stay informed!

Fourth quarter stock market performance

*Source: Bloomberg, fourth quarter price performance of the S&P 500 Index.*

Volatility index indicates pessimism, but not panic.

Since reaching a post-pandemic high in July, the market has seen a pullback of nearly 7% throughout August and September. This marks the third dip of this magnitude in the past year, with stocks falling 7.8% in February-March and 7.3% last December. But here's the silver lining - after each of these dips, the market rallied impressively. Post the Feb-March dip, the market bounced back by 7.5% in the following month, and similarly, it rallied by 7.6% in the month succeeding the December dip. These rebounds underscore the potential opportunities that short-term pullbacks can present. :chart_with_upwards_trend: What's interesting about this latest dip is that it hasn't mirrored the volatility seen in previous episodes. The VIX index, often dubbed the "fear index" as it gauges short-term market volatility, did rise in September, but it stayed well below its levels during the sell-offs in March, December, and October. In the last two months, we've only seen eight days where the stock market experienced a daily move greater than 1%. This is in stark contrast to the 20 1%-plus daily moves witnessed in February and March of this year, and the whopping 25 such moves in September and October last year.

VIX (Volatility) Index

*Source: FactSet. CBOE Volatility Index.*

Lower volatility doesn't necessarily mean that the market can't continue to experience weakness. However, we believe it signals a more orderly pullback where risks, such as potential Federal Reserve errors and political disruptions, are more visible and counterbalanced by positive factors. These include a robust labor market, declining inflation, and resilient corporate profits. Last week's market movement underscored this equilibrium. It culminated in a significant swing on Friday, which began with a robust rally triggered by the latest inflation report. The core personal consumption expenditure price index (core PCE) - the Fed's preferred inflation measure - dropped below 4% for the first time in over two years. However, the rally lost steam as the day progressed, with markets closing lower on Friday. Analysts speculate that this downturn may be due to concerns about a potential government shutdown over the weekend.

Core PCE Price Index (Y/Y %)

Stocks on the move

Here's a quick rundown of some of the major stock movements driven by quarterly earnings, analyst ratings, or other news:

🍺 Anheuser-Busch InBev

(BUD) had a good day, with shares rising 3.6%. This came after Bank of America upgraded the stock from "neutral" to "buy", citing factors such as easing costs of goods sold. Cheers to that!

💘 Bumble

(BMBL) also saw a boost, with shares up by 3%. Loop Capital Markets upgraded the stock from "hold" to "buy", pointing to a strong cash balance and impressive free cash flow generation. Love is in the air!

🚢 Carnival

However, it wasn't smooth sailing for (CCL). Shares fell by more than 5% after the cruise operator projected a larger-than-expected fourth-quarter loss, overshadowing stronger-than-expected results for the third quarter.

👟 Nike

(NKE) sprinted ahead with a 6.7% rise. The apparel maker reported stronger-than-expected quarterly earnings, although revenue fell short of forecasts.

🚗 Tesla

(TSLA) also had a good run, with shares up by 1.6%. Canaccord Genuity reiterated a "buy" rating on the electric vehicle maker's stock.

💊 Walgreens

Lastly, (WBA) shares rose 6.4% after Bloomberg reported that the company is considering Tim Wentworth, a former Cigna executive, as its next CEO.

Looking Ahead to This Week

As the U.S. grapples with a government shutdown, the release of governmental economic data may be delayed. However, if the data can be released, the spotlight this week will be on the labor market. We're expecting September's jobs report on Friday, which will be preceded by updates on private unemployment and the Job Openings and Labor Turnover Survey (JOLTS).

Also on our radar are the September purchasing managers' indexes (PMIs) for manufacturing and services from the Institute for Supply Management, along with finalized readings from S&P Global. Other key data to watch out for include August's trade balance, factory orders, construction spending, and consumer credit.

In the central bank space, all eyes will be on Fed Chair Jerome Powell as he participates in a roundtable discussion in Pennsylvania.

This week promises to be an interesting one for investors, as these economic indicators could provide valuable insights into the health of the U.S. economy amid the ongoing government shutdown. President Joe Biden signed into law a stopgap bill on Saturday to avert a government shutdown, few hours before deadline. The bill, which passed the House and Senate with bipartisan support, will keep the government open through November 17.

The passage of the bill came after weeks of uncertainty and infighting among House Republicans. House Speaker Kevin McCarthy announced the stopgap proposal Saturday morning after a last-ditch GOP stopgap bill failed to advance in the House on Friday.

The measure includes natural disaster aid but not additional funding for Ukraine or border security.

A Looming Government Shutdown

We're here to discuss a topic that could have significant implications for the U.S. economy - a potential government shutdown. If this happens, it would be the first shutdown since 2019, and the effects could be far-reaching.

What happens during a shutdown? During a shutdown, millions of government workers, including air traffic controllers and military personnel, could be furloughed or asked to work without pay. Key federal aid programs like the Supplemental Nutrition Assistance Program (SNAP) could be affected, and national parks might have to close their gates.

What's the potential economic impact? Analysts at Goldman Sachs estimate that a shutdown could shave off 0.2 percentage points from GDP growth for every week it lasts. However, they also suggest that growth could rebound once a deal is reached and the government reopens. It's worth noting that federal pay, which would be severely curtailed in a shutdown, accounts for roughly 2% of U.S. GDP.

How could this affect economic data? Agencies that publish economic data, like the Bureau of Economic Analysis (BEA), Bureau of Labor Statistics (BLS), and U.S. Census Bureau, would also shut down. This could leave Federal Reserve policymakers in the dark, without critical data to guide monetary policy decisions. This is particularly concerning as the next meeting of the Federal Open Market Committee (FOMC) is scheduled for Oct. 31.