Friday, 9/29/2023 p.m.
- Stocks lose momentum and end the month modestly lower – After opening higher on Friday on enthusiasm around a better core PCE inflation reading, stocks ended up closing the day modestly lower. This came as a last-minute attempt by Speaker Kevin McCarthy to keep the U.S. government open did not pass. The S&P 500 is down about 4.8% for the month and is lower by around 6.4% since its recent high on July 31. The technology-heavy Nasdaq saw bigger losses, pulling back 5.5% for the month and 7.5% since July 31*. Bond yields held steady on Friday, with the 10-year Treasury yield at 4.58%*, still near the highs of the cycle. The rapid rise in yields this month, with the 10-year up nearly 0.5% in September, has weighed on both stock and bond returns. However, in our view, yields may be heading toward a peak, which would be welcomed by equity and fixed-income investors.
- Core inflation data continues to show signs of moderation – U.S. PCE (personal consumption expenditure) inflation data for the month of August was in line with forecasts that called for a tick higher in headline inflation and cooling core inflation. Headline PCE inflation data climbed to 3.5% year-over-year in August, in line with expectations but above last month's 3.3% reading. Meanwhile, core inflation eased, up 3.9%, lower than last month's 4.2% reading*. We saw a similar diversion between headline and core CPI (consumer price index) inflation earlier this month as well. This comes as oil and energy prices have climbed higher, adding upward pressure on headline inflation. Core inflation, however, has benefited from falling used and new car prices, as well as some cooling in wage growth. In our view, core inflation may continue to move gradually lower as the shelter and rent component moderates, and as services consumption and wages potentially ease.
- U.S. government-shutdown headlines continue as deadline approaches – The likelihood of a U.S. government shutdown continues to grow higher as the October 1 deadline approaches, and the two parties continue to struggle to pass a continuing resolution. It is important to note that shutdowns have been a regular occurrence in recent history but have not lasted long. Since 1976 there have been 20 government shutdowns lasting for a day or more. The most recent one in December 2018 lasted 35 days, setting a record as the longest in U.S. history*. From an economic standpoint, we would expect a short-term slowdown in growth around the shutdown period but a quick recovery in activity in the subsequent months. In other words, a shutdown would displace or delay spending and economic activity, not eliminate it. From a market perspective, the uncertainty that a potential government shutdown introduces can lead to a short-term uptick in volatility. But as with most political events, government shutdowns have historically had little lasting impact on equity performance. Stocks were positive half the time during the government closures and were higher in most cases three and six months later.
- Stocks rebound as the morning rise in yields reverses – The rally in bond yields has kept investors on edge this week, as the 10-year Treasury yield kept making new highs for the year. But comments from Chicago Fed President Goolsbee about the risk of overshooting on interest rates and a downward revision in second-quarter personal consumption helped push rates lower in the afternoon. The reversal of the morning strength in yields benefited mega-cap tech and small-cap stocks, which led to the rally in stocks today. WTI oil prices declined after briefly exceeding $95 a barrel yesterday for the first time in more than a year*.
- The economy continues to do well, but it is softening - The focus of the economic front this morning was the second-quarter GDP estimate and the weekly jobless claims. Overall GDP rose at a 2.1% annualized pace, which was unchanged from the prior revision but was slightly below the 2.3% estimate. Stronger business investment helped offset the slowdown in spending. Personal consumption rose 0.8%, the slowest pace in over a year, a sign that high borrowing costs are slowly applying the brakes on spending*. On a positive note, jobless claims remain low for now, indicating that job security and income gains will continue to provide a buffer against a slowing economy.
- Sentiment is subdued heading into month-end - September is living up to its reputation for being a challenging month for markets. Large-cap equities are down about 5%, the worst monthly performance this year, while September has been the worst month for bonds since last September.* The market correction is in part driven by the Fed signaling that rates will likely remain higher for longer, pressuring valuations. Concerns around a government shutdown, the resumption of student loan payments, and the autoworkers strike have also dented sentiment. In our view, after a strong rally in markets, a pullback is normal, and it is likely taking place with the broader uptrend in stocks that has been established over the past 12 months. The favorable downturn in inflation over the past year, the economic resilience, and an approaching end to the Fed's rate hikes support a positive outlook. But this won't eliminate bouts of volatility along the way.
Angelo Kourkafas, CFA
- Stocks finish mostly flat, small-caps outperform – Stocks closed near the flat line on a quiet day in terms of economic releases. The Senate voted Tuesday night to advance a short-term funding measure to avoid a government shutdown, which would provide funding through November 17. However, the proposal would still require a final vote in the Senate, along with approval from the House of Representatives, raising concerns on the likelihood of approval. On the economic front, durable goods orders rose by 0.2% month-over-month in August, ahead of expectations for a slight contraction*. U.S. small-cap stocks were the standout today, rising about 1% and outperforming large-cap peers*. Yields finished the day higher, with the 2-year Treasury yield rising to over 5.1% and the 10-year yield closing around 4.6%*.
- Markets look ahead to Friday's PCE inflation data – The August PCE (personal consumption expenditures) report will be the next batch of inflation data for markets to digest to help gauge the path of future monetary policy. Consensus expectations are for headline PCE to rise to 3.5% year-over-year compared with the July reading of 3.3%*. Core PCE (which excludes food and energy) is expected to continue its downward trend from a 4.2% year-over-year rise to 3.9%*. If expectations come to fruition, the PCE data would align with the August CPI (consumer price index) report, where headline inflation ticked higher, driven by an uptick in energy costs, while core CPI continued to trend lower. Our view is that core inflation readings should continue to trend lower throughout the remainder of this year and into 2024. Shelter has been a component of CPI and PCE inflation that has remained elevated. Yesterday's S&P Case/Shiller Home Price Index showed only a 0.13% year-over-year rise in home prices, which could be supportive of easing shelter costs in the months ahead*.
- Third-quarter equity performance shows change in leadership – Much of the upside behind equity-market performance this year has been driven by enthusiasm around artificial intelligence (AI) and growth-style companies. However, since the start of the third quarter, the information technology sector has declined by over 6%, underperforming the S&P 500**. Much of this decline has come following last Wednesday's FOMC meeting that provided the Fed's economic projections, which signaled policy rates could remain higher for longer. Energy has been the strongest-performing sector during this time period, rising by over 10%, as oil prices have spiked to over $90 per barrel. Communication services is the only other sector with positive returns quarter-to-date.
Brock Weimer, CFA
**FactSet, GICS sectors of the S&P 500
- Stocks fall amid ongoing anxiousness around Fed policy – Equities gave back Monday's gain and then some, trading markedly lower on Tuesday, as investor sentiment has been soured by the potential for the Fed to hold rates higher for longer. Looking under the hood, beyond the help the energy sector received from higher oil prices, defensives like health care and consumer staples held up better today, while the consumer discretionary and technology sectors were among the worst performers. Global equities were also lower on Tuesday. In the bond markets, rates were little changed, with 10-year rates remaining above 4.5%.* We don't view Tuesday's pullback as a reflection of a shift in the broad market backdrop. Instead, we think this spate of stock-market weakness is an adjustment to the prospects of the Fed keeping monetary conditions tight and investors acknowledging additional economic uncertainty in an environment where the Fed keeps its foot on the brake a while longer.
- Rates and government shutdown weighing on risk appetite – The post-Fed meeting jump in interest rates continues to be the dominant influence across financial markets. Ten-year Treasury yields held steady, perched near their highest since 2007.* A variety of Fed officials will now be on the speaking trail, and the message is likely to reinforce their commitment to undercutting inflation and to emphasize the Fed's willingness to tighten more if necessary. We view this more as a way to keep market expectations in check than a confirmation that there are more material rate hikes on the way. Nevertheless, markets may remain in a cautious stance for a while longer until additional inflation readings can be evaluated. A looming government shutdown is adding to the risk-off posture in the stock market. Moody's issued a warning noting that a shutdown would be a factor in the U.S. credit rating, though it confirmed that it does not expect debt payments or the broader economy to be disrupted, a view that we agree with. Nevertheless, growing headlines around the mechanics of a shutdown, along with the additional focus it puts on the deep partisan divide in Washington, could add a bit more temporary anxiety to the markets over the coming days.
- Housing data provides mixed signals – A batch of housing reports out on Tuesday showed a mixed picture of resilience and weakness in housing investment, as it's clear to us that higher interest rates are taking some wind out of the housing market's sails. Building permits rose last month, hitting their highest since last September, indicating that new construction activity is holding up. Meanwhile, new home sales declined sharply, and the pace of home-price appreciation continues to moderate. The S&P/Case-Shiller Index showed that prices rose by a lower-than-expected 0.13% over the last year. While this ends a string of four straight months with year-over-year declines in the home-price index, it remains well below the double-digit pace of appreciation experienced through 2022.* This tells us that higher rates are weighing on purchase activity and home values, though this does offer the silver lining that the upward pressure on inflation coming from shelter costs should continue to abate.
Craig Fehr, CFA
- Equities are flat to start the week – Equity markets were flat or modestly higher on Monday, with the technology-heavy Nasdaq leading the S&P 500. This comes even as U.S. Treasury yields continue to climb higher, with the 10-year yield now above 4.5%, at its highest for the year. The recent rapid rise in yields, in large part driven by last week's Fed meeting, has put downward pressure on both stocks and bonds in recent days. The longer-duration and growth sectors of the market have lagged overall. The Nasdaq is down about 3.4% since last Wednesday's Fed meeting, while the broader S&P 500 is down about 2.8%*. Meanwhile, the U.S. dollar, which is often considered a safe-haven asset in times of uncertainty, also continues to climb. The DXY dollar index is above 105*, also at its highest for the year, adding some pressure to multinational companies and global equities broadly.
- The Fed's message was clear: Higher for longer - The Federal Reserve held its September meeting last week, and the message from Jerome Powell was clear: The Fed will continue to keep rates elevated until inflation moves more convincingly toward 2.0%. The Fed held rates steady at 5.25% - 5.5% at this meeting but kept the option of an additional rate hike on the table, maintaining its outlook for a peak fed funds rate of 5.6%. The Fed's new set of projections also reduced the number of potential rate cuts in 2024, from 1.0% to 0.5% of cuts next year, implying that the elevated interest-rate environment may last longer than expected. In our view, while Powell and team may continue to signal that they are not done raising rates, there may be a confluence of factors that keep them on the sidelines. Inflation, and especially core inflation, continues to gradually move lower; the labor market has shown early signs of cooling; and the consumer, which has been the backbone of the economy, has been drawing down their excess savings and is now facing higher oil prices. Thus, the Fed may need to revisit its more optimistic forecasts for the economy and unemployment in the months ahead.
- U.S. government shutdown headlines may start to ramp up – As the new fiscal year for the government approaches on October 1 with no deal in place to enact the 12 annual appropriation bills, federal agencies may be forced to cease all nonessential functions, also known as a partial government shutdown. There have been 21 U.S. government shutdowns in recent history, lasting from two days to 35 days*. From a market perspective, government shutdowns have had little impact on equity performance. Stocks have been positive half the time during the government closures and were higher in most cases three and six months later*. While we would anticipate some volatility leading up to a potential shutdown and perhaps through the shutdown period, we would expect markets to be driven over time by fundamentals, including economic and earnings growth, as well as interest-rate policy.
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