The market continues to reset as rates climb higher
ANTHONY SAGLIMBENE – CHIEF MARKET STRATEGIST, AMERIPRISE FINANCIAL
WEEKLY MARKETS COMMENTARY — September 26, 2022
Moving toward normal can be painful when your perspective isn't set correctly. And how painful that process feels depends on your definition of normal. From a market perspective, if an investor felt the S&P 500® Index highs of early January were normal, the slide lower this year has undoubtedly been a jarring experience. By Friday's close, the S&P 500 was down over 23% from its January high and down 22.5% year-to-date.
However, little was typical about the trillions of dollars in fiscal and monetary support spent propping up U.S. economic growth and cushioning the coffers of consumers and businesses during the pandemic — which helped fuel the record stock highs through early January. Further, the Federal Reserve's zero interest rate policy and bond-buying program throughout 2021, when U.S. GDP grew +5.7% (more than 3X its long-term growth rate) and S&P 500 profits soared +48% year-over-year, propagated excessive risk-taking and inflated asset prices through much of last year. Today, the market is simply resetting back to a historical level of growth, where fiscal support is absent, monetary policy is tightening, and investors search for the proper level to value assets in such an environment.
Unfortunately, the backdrop of record-high inflation and global central banks caught flat-footed in addressing the threats of price pressures running so rampant through the world today has prompted a more violent response in markets. That said, the S&P 500 remains roughly +14% higher from the start of January 2020 and approximately +60% higher from the pandemic lows in March 2020. Bottom line: Over the last two-plus years, investors have faced once in a 100-year pandemic, the near-complete shutdown of the global economy, historical fiscal/monetary responses coordinated across the world, a disjointed reopening of the global economy, rising geopolitical threats, and now multidecade highs in inflation. And despite all of that, the S&P 500 remains higher than at the onset of all these issues. In our view, a little perspective can help reframe what has been a challenging year for investors.
Investors need to plan to weather more storms in the market
As volatile and painful as the first nearly nine months of 2022 have felt for stock and bond investors, nothing about this year's market action should cause investors to shift materially away from their long-term investment strategies. We believe stocks and bonds should eventually find a new equilibrium level. In the process, asset valuations should reset to new and lower levels that investors find attractive, at which point asset prices should begin to rise again. Yet, over the very near term, stock and bond prices could remain volatile and subject to investors' interpretation of the direction of rates and inflation.
Nevertheless, stock weakness should be viewed as an opportunity to acquire quality assets at reduced prices. Investors should continue to lean on diversification, favor quality assets in the U.S. and recognize security selection could play a more prominent role in generating returns over the coming quarters. However, long-term opportunities will eventually present themselves to patient investors. Our advice: plan to weather more storms as we roll into October, avoid timing mistakes and focus on what you can control (e.g., how and where you invest). These storms shall pass, and once economic activity and profits look set to grow more steadily, so too should stock prices.
U.S. stock averages continue to face bear market pressures
Stocks continued to put an exclamation point on what's turned out to be a very challenging September. The S&P 500 declined 4.7% last week, logging its third straight week of 4.0% or more declines. The NASDAQ Composite slid 5.1% on the week, its second straight week of 5% or more declines, while the Dow Jones Industrials Average lost 4.0%. With one more week of trading left in the month, the S&P 500 is on track for its worst September performance since 2011, while the NASDAQ is on pace for its worst September since 2008. Notably, the S&P 500 fell to a three-month low last Friday, while the Dow closed at its lowest level of 2022. With the previous week's losses in hand, the Dow starts this week within a whisper of a bear market, currently down 19.9% from its intraday high set on January 5. While most would assume the Dow's near 20.0% decline from its recent high now places the 30-stock index in the same company as the S&P 500 and NASDAQ, until it's officially breached, semantics to traders matter when defining a bear market. For simplicity's sake, let's just assume that the major U.S. stock averages continue to face bear market pressures.
All eleven S&P 500 sectors closed lower by at least 2% last week. Energy (down 9.0%), Consumer Discretionary (down 7.0%), and Real Estate (down 6.4%) were the S&P 500’s worst performers. However, Consumer Staples (down 2.2%) and Utilities (down 3.1%) helped mitigate the selling pressure.
The U.S. Dollar Index rose 3.0% last week, seeing its biggest weekly rally since March 2020, while U.S. Treasury prices were sharply lower. The 2-year U.S. Treasury yield rose above 4.25% (its highest level since 2007), as the 10-year U.S. Treasury yield rose above 3.80% for the first time since 2010. The boost in the dollar and yields were driven by the Federal Reserve raising its fed funds rate for the fifth time this year and by 75 basis points for the third consecutive meeting. Over the last three meetings, the fed funds rate has increased by 225 basis points. That's the fastest pace of hikes in a three-meeting span since former Fed Chair Paul Volker lifted rates by 4.0% in a single meeting (May 1981) and before rate policy was officially announced. Based on its most recent projections, Fed officials currently see rates climbing higher through the front half of 2023, unemployment rising, inflation running hotter for longer, and growth slowing more than projected in the summer. Our own economic estimates call for stagnate growth over the next few quarters, higher unemployment, and lingering inflation pressures — despite still healthy consumer balance sheets. Notably, the Fed is now actively pushing against economic growth and demand to curb inflation. Moving forward, further rate hikes from here should be assumed as a direct headwind to growth and asset prices. Bottom line: The current investing landscape is not conducive to riskier assets like stocks.
In the latest American Association of Individual Investors Survey, bullish sentiment dropped to 17.7% from 26.1% in the prior week. That's the biggest sequential drop since early June, and not surprisingly, the last time stocks were grappling with such outsized selling pressures. Conversely, bearish sentiment in the survey jumped to 60.9% from 46.0% previously, leaving the bull-bear spread at levels last seen during the dot-com bust, the depths of the pandemic, and not too far away from the trough seen during the great financial crisis in 2008.
In other items of note during the week, West Texas Intermediate (WTI) oil dropped 7.8% to $79.14, its lowest level since January. Gold finished down 2%, ending at $1,651.70 per ounce. U.S. housing data continued to show signs of softening. However, first reads on the September Purchasing Managers Indexes showed manufacturing and services activity coming in stronger than expected and above August levels. Overseas, Japan's Ministry of Finance intervened to support the yen's multidecade slide against the dollar for the first time since 1998. And the British pound dropped to a 37-year low against the greenback as the United Kingdom unveiled a plan to boost spending, cut taxes and increase borrowing through bond issuance. Finally, during the week, European PMIs contracted further, showing the region could soon be entering a recession.
Fed member speeches a major focus this week; market sentiment continues to be bearish
In the final week of September, investors will receive no less than 13 Fed member speeches to help add color to last week's policy decision and undoubtedly add a bunch of noise around how to shape policy moving forward. Fed Chair Powell is scheduled to speak on Tuesday and Wednesday, though it is unlikely he will add any insight above what he provided in last week's press conference. August new home sales, durable goods orders, a final look at Q2 GDP, and August personal income and expenditures line the economic calendar. In addition, the Fed's preferred inflation gauge, the core Personal Consumption Expenditures (PCE) Price Index, is expected to have risen in August versus July.
This week, stocks will look to digest this information as they search for near-term support after falling to very oversold conditions last week. Notably, the S&P 500 breached the lower bound of its relative strength index on Friday, which typically marks a level where traders become more willing to reengage in buying activity. Further, most sectors of the S&P 500 are either oversold or very oversold, based on their 50-day moving average. This is just another way of expressing that sentiment is very bearish, and price action has been one-sided to the downside as of late. But history suggests markets tend to mean-revert back to the average over time. After such aggressive moves to the downside over recent weeks, we wouldn't be surprised if markets look to soon catch their breath.
Sources: FactSet and Bloomberg. FactSet and Bloomberg are independent investment research companies that compile and provide financial data and analytics to firms and investment professionals such as Ameriprise Financial and its analysts. They are not affiliated with Ameriprise Financial, Inc.
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