Investment Insights

 — Steve Orr 

Sloppy September

Welcome to last place. September ranks last in stock performance over the past 70 years. Hey, somebody has to bring up the rear. The S&P 500 has declined between 4% and 9% in the past four Septembers. Fingers point to end of the government fiscal year, quarterly tax payments and the blackout period for stock buybacks. This year you can add Middle East strife, weakening foreign economies and the U.S. election to the Wall of Worry.

Friday’s price action was a good example of OK news being bad and bad news being “badder” (not baddest, yet). Most of the major indices soured on job openings falling earlier in the week. The August payroll number Friday morning came in below expectations at 142,000 net-new jobs. That is just OK, and it reflects the slowdown from 2023’s 242,000 average. The internals were bad, however. June and July were revised lower, making the net gain just 56,000 during those months. Almost all of August’s job gains were in part-time employment. Since shutdowns started in 2020, foreign-born workers have increased by 4.4 million while native-born workers have fallen by 833,000. The unemployment rate ticked back down 0.1 to 4.2%, mainly due to unemployed workers coming into the workforce.

Over one-third of the job growth this year is in the government and healthcare sectors. This year the Federal government is on track to take in $4 trillion in taxes and spend $5.6 trillion. That continues a trillion-plus deficit trend started during shutdowns. One wonders if government job growth will stop or reverse if Congress ever comes to its budget senses. Oh wait…

Bouncing

The first bounce in a Bear cycle or correction is usually the best time for traders to “buy the dip.” That trade for this cycle came in the early August timeframe after the 8/5 low. Investors are a different animal. If not already invested, the next breakout would be a point for a long-term investor to add to positions. In this bounce, the S&P 500 peaked at 5,648 on the 30th and did not break above the prior high set on July 16. Patiently waiting to get through September and October is key for investors. Most election years end with stock indices in the green and the S&P, Dow Industrials and NASDAQ remain well into positive territory.

Are we confident a bounce above July’s all-time highs is ahead? Yes, but we are unsure of the timing. U.S. stocks remain in a long-term (“secular”) Bull market, despite the NASDAQ 100 and other pockets of the market sliding into correction zones (down -11% from highs). If our base case is correct that the U.S. avoids a recession and has a soft landing, history says stocks should rally hard. Uncertainty around the U.S. election and seasonal weakness are enough reasons to sit on the sidelines waiting for stocks to turn. Election years usually see a small rally after the election.

Before the bounce, markets have to set a new bottom. The easy answer for the S&P 500 is to retest its 5,119 low from August 5. That was an intraday low; the close that day was 5,186. That level is almost 5% below today’s (Monday) trading level and 8% below July’s all-time high. That would be a very reasonable September shake-out and selloff. 

Undone

After fits and starts the past four trading days, the two-year Treasury Note yield has finally dropped back below the 10-year’s yield. Admittedly it’s only 3 basis points (3.67% vs 3.7%), but after 567 trading days the Treasury yield curve is once again positively sloped. The inversion is the longest on record in the post-war era, eclipsing the once-unfathomable 420 trading days set back in 1978 to 1980 (cue Gloria Gaynor’s “I Will Survive”).

Wall Street has pounded the table during the yield curve inversion that once the curve reverts, a recession will be close behind. We understand the sentiment and mostly history agrees. However, we wonder about the choices on election day. Both parties are inclined to keep spending and spending. Taking deficit spending from a mere $200 billion or so a year to the stratospheric levels of nearly $2 trillion has kept the economy out of recession since shutdowns. Our base case is that spending will resume after the new Congress convenes in January. 

OK, one week.

We threw in the towel on rate cuts after Powell’s Jackson Hole speech in August. The Fed will cut short-term rates a quarter-point next Wednesday. It will not matter much to the mortgage or credit markets in the short term. Some business borrowers will see relief at their quarterly rate resets. Most individual borrowers will not see any difference. Market sentiment will relax a bit but immediately go into speculation mode about how fast and how far the Fed will go.  

Inflation is stagnating in the high 2% to 3% area and will likely not fall much further. Job losses started a year ago and are not finished. A cut this month would be a precautionary signal to markets, rather than the Fed waiting and reacting late to realized bad numbers.

We think the markets have overshot again, predicting too many rate cuts and moving rates lower than they should be. But we can only invest in reality: Rates are where they are and represent a small spread over inflation. That is a positive development that was not available to investors in the inflation spike of 2021 to 2023. Next Wednesday, the Fed staff and members will update their projections as the number of rate cuts, inflation and growth outlooks. Here’s betting the number of cuts will again be less than the market: four this year versus six. That would take the year-end Fed Funds overnight rate to a range of 4% to 4.25%.