Weekly Market Update

A tumultuous third quarter ended today with a whimper, as the almost 14% S&P 500 rally from the end of June through mid-August proved to be a short-term and unsustainable bounce thanks in large part to a relentlessly hawkish Federal Reserve that has propelled interest rates to levels not seen in well over a decade. September is historically the weakest month of the year for the S&P 500, and we anticipated choppy market action, but the Fed’s stated commitment to holding rates higher for longer has repeatably surprised markets. Seasonality alone is never a sole reason to buy risk assets, but it is notable that Q4 is far and away the best quarter for the S&P 500 rising over 4% on average over the past 20 years (per FactSet). Furthermore, the track record around midterms is incredibly strong, so investors have continued to try (unsuccessfully) and front-run inflation reports, hoping that momentum to the peak inflation narrative could amplify seasonal strength into 2023.

While markets have become resigned to take the Fed at its word as it insists that rates will remain higher for longer, it is important to note that our global economy is structurally very different than it was during the days of Volcker, the former Fed Chair that Jerome Powell has evoked multiple times for having conquered inflation in the 1970s. For example, when Volcker was in his heyday, US debt-to-GDP was about 35%. Today it is over 130%, so financing that mountain of government debt has become significantly more expensive with rates surging. In addition, the proliferation of globalization has made US monetary policy much more important on the world stage and we are seeing significant signs of economic strain overseas as the US dollar has reached its highest levels in over 20 years and has added to global inflationary pressures (see Japanese Yen, British Pound, Euro, etc.). Ultimately, the Fed insists that it will stay the course and hike into a global economic slowdown, but make no mistake, pressure both politically and economically on the Fed to strike a less hawkish tone is mounting. Unfortunately, Friday’s personal consumption expenditures report, the Fed’s preferred inflation gauge, did not cool as much as expected and probably adds to the Fed’s resolve. However, it was notable this week that per the Case-Shiller home price index, housing prices fell in July for their first time since 2012. The October 13th consumer price index (CPI) report looms large, and we anticipate more volatility as the Q3 earnings season heats up in a couple weeks and investors scrutinize earnings guidance. In the meantime, barring a flare up in geopolitics (we are closely monitoring the Nord Stream sabotage), we expect interest rates to in large part lead stocks – higher rates probably equate to more stock market weakness, while a respite in this recent surge in yields likely allows stocks to attempt a rally.

Ian G. Browning, CFA
Managing Director, Investment Strategies | Shareholder