An Oversold (and Confused) Market
• In mid-July, 87% of the S&P stocks exceeded their 50-day moving average. By mid-August, the high point had fallen to 33%, and as of September’s close, the number of stocks still holding above their 50-day moving average slipped to 14.7%.
• August’s Consumer Price Index rose to an annual 3.7%, well below the 2022 high of 9.2% but still higher than the Fed’s 2% target.
• With the nation’s new fiscal year beginning October 1, markets remain nervous over this weekend’s temporary budget resolution, ballooning budget deficits and outlier risks of another rate hike.
• In the first quarter of 2023, the U.S. economy grew GDP by an annual rate of 2%. In the second quarter, initial GDP estimates rose to 2.4%.
• Real Gross Domestic Product (GDP) increased at an annual rate of 2.1% in the second quarter of 2023, according to the “final” estimate from the Bureau of Economic Analysis. Third-quarter forecasts from the Atlanta Fed’s GDPNow model is targeting 4.9%.
September has held true to form this year. Generally, this month is a more difficult period for investors, and once again, there were no surprises. As of this writing at month’s close, the S&P is down nearly 5% for the month, following a decline of 1.8% for August. Optimists know, however, that these two months are well ahead of returns for this time last year when the S&P had fallen by 4.2% in August and 9.3% in September 2022.
And more good news, the last three months of the year tend to be rather bullish. According to Bespoke Research, over the past 50 years, fourth-quarter periods tend to be in positive territory nearly 70% of the time. A case in point: During a relatively difficult market last year, the monthly returns for the final three months in 2022 collectively averaged nearly +7.5%.
Also putting this year into perspective, despite challenging rate hikes, sticky inflation concerns, overseas wars and other factors, the markets to date have performed quite well. Pushing through a multitude of barriers, the S&P is up year-to-date more than 11% ̶ great returns even for “normal” year averages. Unfortunately, however, this performance has not been uniform across all markets, proving again that stock picking—or luck—matters. Small-cap stocks (Russell 2000) are marginally in positive territory, as is also the case with the Russell Value Index. Meanwhile, growth stocks (Russell Growth Index) are up more than 24%. For those of us following the dividend stocks, one favorite benchmark, the I-shares Select Dividend ETF is off by 8% for the same time frame.
Unfortunately, a myriad of market and economic headwinds expected over the next few months and into early next year will likely challenge investor staying power. Through most of this year, the economic data has remained strong enough to suggest no economic slowdown coupled with a continuing drop in inflation. Since August, however, the data has become more mixed, clouding Fed’s outlook and actions as well as market confidence. At this point, we are unsure about how many—if any—rate steps are still to be climbed. But with only a short-term budget resolution in place in addition to an autoworkers’ strike and an upcoming year of election discord, there is certainly more market volatility in the foreseeable future.
Consumer Inflation Spillover and Impact
As we’ve noted in prior commentaries, markets are concerned about whether or not consumers have the capacity to remain resilient to the cumulative impact of the past 18 months’ rate hikes. September’s Fed meeting certainly offered a reprieve from higher rates, but the verdict is still out on what may occur at the next Federal Open Market Committee (FOMC) meeting in November.
The job markets continue to signal strength, although waning a bit lately. In August, unemployment increased nominally by 0.3%, pushing unemployment up slightly to 3.8%. The number of new jobs added in August, however, increased by 187,000 positions, primarily a function of new job seekers joining the workforce. As has been the case over the prior months, job adds were across a broad spectrum of industries, including leisure and hospitality, social work, construction, transportation and business professionals. We see these signals as pushbacks against the idea that companies are cutting back in key sectors of the economy.
Wages also played catch-up with inflation, as the 12-month average hourly payroll gained an annualized 4.3% in August. Despite rising interest rates cutting into corporate margins, companies have continued hiring—albeit at a slower pace. A number of companies have opted to bypass staff layoffs and focus more on workforce attrition to “rightsize” their human capital needs, thereby minimizing the loss of corporate talent.
Although jobs have held up through the market volatility, the noise recently took its toll on respondents to September’s Conference Board Consumer Confidence Survey. The headline index fell more than expected for the second consecutive month, and now sits at its lowest level since May. The expectations component of the survey fell to a level of 73.7 (below 80 is indicative of a recession). What is interesting, however, was the commentary from the Conference Board noting that the index data might be the result of headline news about job layoffs, inflation and rate hikes. Most notable though was that in the 12-month outlook, survey respondents remained relatively upbeat.
Although the inflation story continues to settle down from the near record highs of last year, August provided a reminder that certain prices have remained sticky. This month was especially notable with the 5.6% increase in gasoline prices. In terms of the Consumer Price Index (CPI), the monthly impact was +0.6%, which pushed the annual inflation reading up to 3.7%. Backing out the impact of energy and food though, the headline inflation reading actually increased from July’s 3.2% to 4.3% last month. But as we’ve mentioned in the past, until the economy and markets resume to a level of normality, monthly anomalies will continue, which are likely to self-correct in subsequent months. August’s anomaly may prove to have been the spike in gasoline prices.
The recent FOMC meeting delivered as expected, holding interest rates steady at a range between 5.25%-5.5%. While investors were looking for more “market-dovish” commentary or rate capitulation signals, neither wish came true. With investors expecting otherwise, the stage was set for the market’s volatility throughout the final trading days in September.
Fed officials also seem to be growing more hopeful in their ability to cool inflation without a recession or a sharp rise in unemployment. Their expectations are for growth to slow this year and end up closer to their target 2% range next year and for unemployment to go no higher than 4.1% next year, just slightly higher than the current 3.8% level.
Three months ago, Fed officials anticipated U.S. GDP to grow only 1.1% next year, after just 1% this year, and for the unemployment rate to peak at 4.5% next year and still be there at the end of 2025. Current estimates for GDP growth are 2.1% this year and ticking slightly downward next year to potentially 1.5%. Statements from the Fed suggest that the economy will escape the worst recession fears. As Chair Powell commented, “I’ve always thought that the soft landing was a plausible outcome..ultimately, this may be decided by factors that are outside our control at the end of the day, but I do think it’s possible.” I would add another note to these comments recognizing that once it was apparent that we were heading into an inflation spiral shortly after the pandemic peak, the FOMC began a rather aggressive rate hike program. Central banks and global markets were in completely unfamiliar territory following the pandemic shutdown, legislating serial government subsidy programs and zero borrowing rates, and jump-starting jobs and global economies. Now we can add to the list additional complexities such as congressional infighting, higher energy prices, longer-term borrowing costs, resumption of student loan payments and financial subsidies to the Ukraine war effort. Forecasting through these headwinds will require the Fed to be a bit more nimble and judicious in their decisions—no easy path over the next 3 to 4 quarters.
As noted last month, investors are a fickle lot. In July, the American Association of Individual Investors (AAII) poll posted the highest percentage of bulls (51%) in almost two years. In the poll taken on September 27, the bullish percentage had fallen by almost half to a percentage of 27.8%. Poll respondents’ concerns had not changed, namely fears over the uncertain Fed path, inflation levels, overseas conflicts and political rhetoric. It is particularly interesting that these polls seldom solicit thoughts on market valuations, corporate health or earnings expectations.
Reasons for investors to be nervous exist, but as is often the case, investors tend to be more fearful after markets have already been damaged. Investors were nervous last year as well. Beginning this January and through this August, after the S&P 500 had lost 18%, investors pulled near-record outflows of $731 billion from their mutual funds into money markets, according to ISI data.
Whether investors have a change of heart at these market levels remains to be seen, but there are certainly attractive valuations for patient investors. As we’ve noted before, while the markets, such as the S&P or the growth-centric stock indexes, have done well this year, this performance has not been representative of the broader markets. On a year-to-date basis, those sectors dominated by stocks such as Amazon (+51%), Tesla (+103%), Navidia (+197%), Meta (+149%) and Microsoft (+32%) have done well. These examples are the exceptions.
If on the other hand you owned the healthcare S&P sector (XLV) over the same period you were off approximately -4%, Staples (XLP) down -6%, financials (XLF) down -2% or utilities (XLU) down -14%.
As of this writing, the convergence between the best and worst sectors is currently just shy of 52%, with communications up 37.5% and utilities down by -14.4%. This divergence highlights the extreme valuation differences in this macroeconomic backdrop, which typically are trends that tend to “normalize”, that is, reverse themselves. When we look at the number of stocks today that have managed to find support above their 200-day moving average, the impact of the price declines over the past two months becomes more apparent.
On September 27, the percentage of stocks in the S&P above their 200-day moving average support line was 40%, while two months ago it was 70%. The Dow Jones 30 stocks told a similar story, with the most recent data showing 43% were holding above their 200-day support versus 70% two months ago. One category-killer, the tech-centric Nasdaq, has dropped from 61% of the stocks holding above their 200-day support to the most recent 40%.
Today, nearly every sector and major domestic benchmark is considered to be in an extreme oversold territory. It does not mean that stocks quickly reverse, but it does indicate that the majority of holdings within these sector and benchmark composites have moved into oversold territory (2+ standard deviations below their respective 50-day moving averages). Taking a cue from Bespoke Research, over the past two decades, when this occurs within the stock constituents of the S&P 500, Nasdaq or the Russell 2000 (small cap), the performances over the ensuing one, three, six and twelve months are positive. Here’s hoping for another reversion to the mean.
Some Light Ahead?
A number of signals point to the inevitability of a possible hard landing of the economy, including recession. The yield curve inversion is certainly one of the main arguments as is the index of leading economic indicators. The latest data from the Conference Board’s LEI data shows that deterioration continues given August’s still weak new orders, deteriorating consumer expectations of business conditions, high interest rates and tight credit conditions. This has been a continuing theme for the past 17 months. Two issues with the LEI is that four of the 10 indicators are related to manufacturing, which now accounts for a diminished share of payroll unemployment. Non-manufacturing, particularly the services industries, leisure travel and business services are a growing share of our national payroll. Consumer sentiment as a component has likely been overstated in LEI data as it has been noted that much of the downturn in consumer sentiment is primarily due to post-pandemic headline news rather than consumers’ day-to-day spending impact. As to the inverted yield, this indicator has been predicting a recession for quite some time, most notably after the central bank began pumping liquidity into the monetary system, pushing up short-term rates. Today, the reverse has been happening as the Fed has begun tightening short-term rates.
Recent business surveys, such as the ISM Manufacturing and Services PMI readings, have both ticked positive, albeit slightly, this past month. Manufacturing still sits in contraction territory, but I find it interesting that this contraction has not impacted the continued hiring of manufacturing employees or the stable Capacity Utilization data (manufacturing is running at near normal levels).
Recent data from the New York Empire Manufacturing Index recently posted its third month of expansion over the last four months, with business expectations over the next six months matching its highest since March, 2022. This upturn was also reflected in the Philadelphia, Dallas and Richmond Fed Manufacturing composites.
When we look at a rolling three-month scorecard of underlying economic data, ISM Manfacturing/Services PMI, Jobs added and Jobless claims (4-week moving average) and retail sales, the data points to perhaps a softer landing than what we fear from the headlines.
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