The final trading week of September, a month that has traditionally been a difficult one for equities, will begin with stocks trying to rebound from the losses suffered during last week’s selloff. The primary culprit was commentary from Federal Reserve Chairman Jerome Powell following the conclusion of the latest Federal Open Market Committee (FOMC) meeting. The central bank kept the federal funds rate steady at 5.25%-5.50%, but the market reacted negatively to Chairman Powell noting that the lead bank will likely need to keep the benchmark short term interest rate higher for an extended stretch to effectively fight inflation. In essence, this pushed the expected timeline for when the Fed will begin to reverse its monetary policy course further into 2024.
The more-hawkish Federal Reserve drove the value of the U.S. dollar and Treasury market yields higher last week, which was not good news for equities. In addition to making it more expensive for businesses to finance capital investments, the higher discount rates reduce the worth of growth companies that are valued on their future cash flow potential. The higher rates decrease forecasted cash flows when discounted back to present day terms, lowering the company’s intrinsic value, which is the measure of what an asset is worth.
In this environment, the current elevated equity valuations of many companies are hard to justify, hence the selling witnessed last week when the Fed reaffirmed its interest-rate stance of “higher for longer.” The tech-heavy NASDAQ Composite and smaller-cap Russell 2000 Index were the biggest laggards among the major equity averages last week. All in all, it was the toughest week for stocks since March. The futures are indicating a continuation of that selling to begin the new week, with the yield on the 10-year Treasury note, topping the 4.50% mark, likely behind some of the skittishness.
In addition to the likely economic fallout from keeping interest rates higher for a longer period, Wall Street is worried about the recent jump in oil prices. Concerns about a short global supply of crude oil have pushed prices both here and abroad notably higher the last few months. This is a double-edged sword, as the higher oil prices may make it more difficult for the Fed to bring down headline inflation to its 2.0% target, while at the same time hurting economic growth. Higher energy prices will make it harder for households to heat their homes and for businesses to run their operations. The specter of stubbornly high inflation, slowing growth, and a weakening labor market later this year and into 2024 has raised some concern about a possible period of stagflation, which would not be a good backdrop for stocks. On Friday, it was a difficult session for the consumer services, retail, and real estate sectors, with the latter group hurt by the upward move in long-term mortgage rates.
This week will bring some important news on the U.S. economy. After a quiet day today, we will get data on new home sales and consumer confidence tomorrow, durable goods orders on Wednesday, initial weekly unemployment claims and the final revision to the second-quarter GDP on Thursday, and personal income and spending to end the week on Friday morning. The August personal income and spending report has the potential to be the biggest market mover, because it contains the Personal Consumption Expenditures (PCE) Price Index, which is the measure of the U.S. inflation situation tracked most closely by the Federal Reserve. Before we get to that release, we will hear from a number of Federal Reserve Presidents over the course of this week.
In general, the market is facing a lot of uncertainty these days, including whether the Fed can accomplish its end goal of lowering inflation without driving the U.S. economy into recession. There are also worries about a possible government shutdown on October 1st if Congress and the White House can’t reach a resolution on a new fiscal budget and the ongoing United Auto Workers (UAW) strike. So what is an investor to do in this current environment? We continue to recommend holding a portfolio of mostly high-quality companies and cash. It has been a very difficult year for bonds and this may persist in the near term as the Federal Reserve continues to maintain its posture that rates will need to stay higher for longer to effectively stamp out inflation. The price of a bond moves inversely to its yield. – William G. Ferguson
At the time of this article’s writing, the author did not hold positions in any of the companies mentioned.
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