Welcome back readers. Hope you weathered the market storm this past week as we started off September with a big down move.
Last week we wrote about the new highs (blue skis) but also the possible September swoon that often occurs this month. We highlighted the past four Septembers and their consecutive negative performance months. If you have not yet read last week’s Market Outlook or wish to reread it, you can get it here.
You may recall that we described what typically happens after Labor Day when portfolio managers return from their summer getaways and long extended holidays, buckle down and start rebalancing and rotating in/out of companies that look more promising.
Given the technology sell off which began in mid-July, it is apparent that there has been a rotation going on into more “value” oriented stocks which include financials, utility, and recently consumer staple stocks. These are typically considered defensive stocks. Given the non-farm payroll revisions in the past few months (almost 1,000,000 less jobs created) and the monthly job created misses, it is no surprise that portfolio managers are beginning to prepare for an economic slow down. More on this shortly.
It’s a tough time of year for stocks
As we’ve mentioned, it’s a tough time of year for stocks, and election years don’t help as you can see by the chart below.
This widely-known seasonal trend may increase the market’s volatility as digests the current events discussed below.
A big down week.
This was a shortened week due to the Labor Day Holiday. However, stocks began a brutal sell-off from the opening bell on Monday and followed through to market close on Friday with 4 negative days.
The S&P 500 (SPY) had its worst week since March 2023 (the bank crisis) and was down 4.1%. The NASDAQ (QQQ) followed suit and dropped 5.8%. This was the worst week for the NASDAQ since the bear market lows of October 2022. The Russell 2000 (IWM) small cap index was down 5.5% as investors abandoned the smaller companies. This is an area of the market that would normally benefit from a potential reduction in interest rates (more on this shortly) as investors see a more serious slowdown ahead.
While the S&P 500 is now down -4.5% off its record high, the Nasdaq is down twice as much, -10.9%. This weakness is appearing right on time as we have previously pointed out, September has notoriously been the worst month for stocks.
The largest sector of the S&P 500, technology (XLK), had its worst week since the COVID pandemic, declining -7.5%. The Bond market rallied as did Consumer Staples, both defensive sectors, as we saw a clear flight to safety. See charts below that illustrate the negative week for investors:
The Bond market is starting to look much more attractive to investors as rates come down in expectation of an easing by the Federal Reserve. See charts below:
Regarding technology stocks, it was the semiconductor stocks that led the sell off back in July and most certainly this past (shortened) week. The semiconductor sector ETF (SMH) was down 11.5% for the week. Additionallly, another major chip company, Broadcom (AVGO) announced disappointing earnings and investors could not sell the stock quickly enough.
The semiconductor index (SOX) sits precariously at its 50-day moving average. Is a bigger breakdown coming? See chart below:
To see exactly how brutal the MTD (month-to-date) has been so far, we provide the following table of the worst 25 stocks for September. You will notice that technology makes up the biggest share of companies that are getting clobbered thus far. There are 9 semiconductor companies on this list. See chart below:
Investors would have to ask, “Is the AI trade done?”. We are not sure, but ChatGPT did report that far less people are coming to their website and that traffic and inquiries have slowed. Many of these tech AI companies are also expressing that they are “laying off” employees and beginning to slow cap ex given the potential economic slowdown we are facing. (more on this shortly).
What concerns this writer is the number 1 stock up above. That is Dollar Tree. Along the same lines are other retail stocks, Dollar General, Dicks Sporting Goods, Five Below, and possibly even Amazon (AMZN), which has begun to look vulnerable. These retail stocks are the giants of middle America and have all announced disappointing earnings and have all seen implosions of their stock prices.
Additionally, credit card delinquencies accelerated to over 9% this past month, further cementing the idea that consumers are tapped out and have exhausted any leftover stimulus from the pandemic. See retailer stock laggard charts below:
Some aspects of the retail sector are holding up for now. Stocks like Walmart (WMT) remain near their all-time highs.
As Mish often states through the use of her Economic Modern Family, watching Sister Semiconductor (SMH) and Granny Retail (XRT) are often leading signs of the strength of the economy. If you would like more information on Mish’s Economic Modern Family or her book “Plant Your Money Tree” you can go here.
Here is a look at the volatile XRT retail sector ETF. This year it has been very volatile but it is holding up above the January price (AMZN & WMT are helping, for now). See chart below:
Will this be a repeat of August?
You may recall that we had a similar short and abrupt stock market pullback in late July and early August, followed by a significant relief rally into the end of August. The precursor back then was the yen carry trade. Interestingly, the same yen strength could be seen this past week. It makes one wonder if we will yet again see a relief rally for the next couple of weeks? See chart below (this chart shows the Yen/USD ratio and a declining line means the Japanese Yen has appreciated against the US Dollar):
Historically, September 8-18 is a more bullish period and we may see a rally out of this current down move. However, this writer is concerned about a more serious slowdown and possible economic contraction that may be forthcoming the next few months and into 2025.
We see some other signs of this. One chart (below) is from the DBC-commodity ETF chart which shows signs of an economic slowdown. Also, this past week, oil prices were down $4. Other industrial commodities including copper, silver and steel, are all showing weakness as an economic slowdown is being priced in. I will address this in more detail to follow. See the commodity and steel ETF charts below:
An univerted yield curve. What’s comes next?
According to an indicator that just began flashing this past week we may be headed to a recession. Also given that third quarter GDP was revised to 0.60% we may already be close to one.
The inversion of the yield curve, which occurs when short-term bonds offer a higher yield than long-term bonds, just ended after a two-year plus long stretch.
The 10-year US Treasury yield ended the day Friday at 3.71% while the 2-year US Treasury Yield was 3.66%. However several times this week, the yield curve flipped between positive and negative territory.
According to Interactive Brokers’ senior economist Jose’ Torres, investors should pay close attention to the disinversion of the yield curve because of its long-term track record of predicting recessions.
“A positive spread across the 2- and 10-year Treasury maturities following a long period of a negative difference has historically preceded economic downturns”, Torres said in a note on Friday. See a chart describing this below:
“Investors are responding by unloading almost everything,” Torres said, adding that the August jobs report (the NFP came out at 8:30 a.m. on Friday) unlocked the “painful” disinversion. This report, which showed employers added 142,000 jobs, which was below economist estimates of 164,000, along with multiple monthly job growth revisions downward, sparked fresh concerns of a continued slowdown in the broader economy.
This is the first disinversion since September 2019, and the first time the yield curve was positive since July 1, 2022, according to data from YCharts.
What happens to the S&P 500 after a disinversion?
Surprisingly, until such time a recession starts (2 consecutive quarters of negative GDP numbers), the S&P 500 holds up relatively well. However, you can see in the chart below that there are two distinct routes the S&P can take, one with a soft landing (light blue line) and one accompanied by a recession (dark blue line). See chart below:
SPX vs. yield curve. "Following 15 historical Yield Curve un-inversions (since ‘62), the median $SPX return is: +1M: +2%, +6M: -2%, +12M: +9%. In reality, it’s all about Soft vs Hard Landing from here."
The Federal Reserve says they are ready to cut rates.
Friday, Federal Reserve policymakers said they are ready to lower interest rates at the U.S central bank’s meeting in two weeks. New York Fed President John Williams said at the Council on Foreign Relations event “It is now appropriate to dial down the degree of restrictivess in the stance of policy by reducing the target range for the federal funds rate.” But added “by how much and at what pace is still up in the air.”
Fed Governor Christoper Waller, speaking at the University of Notre Dame, went a little further. “If the data supports cuts at consecutive meetings, then I believe it will be appropriate to cut at consecutive meetings," Waller said. “If the data suggests the need for larger cuts, then I will support that as well. I was a big advocate of front-loading rate hikes when inflation accelerated in 2022, and I will be an advocate of front-loading rate custs if that is appropriate”.
I believe there is no doubt that the Fed cuts the overnight Fed Funds at their upcoming September meeting. However, let me lay out 3 possible scenarios, that could occur.
What is different this time?
Many economists and investors have been pricing into their earnings and stock price models quite a few cuts in the upcoming rate reduction cycle. See chart below:
Cuts pricing "This chart ... shows the amount of easing, in basis points, that was priced in by the market at the beginning of each easing since 1990. This one sticks out like a sore thumb."
There is good and bad that comes from interest rate reductions.
Some investors see the potential Fed move as very positive. Any reduction in the Fed overnight Fed Fund rates should help bring down borrowing costs, which will benefit corporate debt, the consumer housing market, credit card borrowing, and a host of other economic sectors. A 25 basis point cut may not do this right away, but if they continue cutting and we see upwards of a 1% cut by year-end, this will be construed positively.
On the other hand, many analysts and historians know that when the Fed begins to cut rates it almost always is a precursor of economic weakness and almost always leads to a recession. This is the fear that many folks have about the beginning of this rate cut cycle. See chart below:
Employment outlook ahead.
Recently many corporate leaders have been deliverirng mixed views about their businesses as well as the economy during earnings calls and post earnings interviews. I believe this is a function of uncertainty from the election as well as the Fed’s posture with regards to interest rate movements. This is likely to lift as we show in the chart below:
CEO employment outlook. "As the Fed starts cutting and the election enters the rearview, increased certainty should improve the hiring environment (or prevent further deterioration)."
A closing note about semiconductor stocks. The future may be much more positive than some of the above charts and indicators illustrate. The good news is after a drop like last week, semiconductor stocks usually rally back.
Post-drop returns. "The good news is that these sorts of drops have led to above-average forward returns for semis. The bad news is that they’re not anywhere near as strong for the market overall." See chart below:
Thank you for following along in today’s Market Outlook. We hope that you have an enjoyable day as we welcome the first full day of NFL games for the 2024-25 season. I know I am one big fan! Good luck with your investments for the coming week. Please let us know what, if anything, we can do to assist you with your investment plan.
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This week's market outlook video is by Geoff Bysshe