The September Effect
The month of September has been, on average, a poor month for stocks going back more than a century. This year was no exception.
Most of the magnificent tech and AI-related companies lost steam and intermediate- and long-term Treasury bond yields rose. Much like last year, energy was the only place to hide during the third quarter, as oil prices resurged.
But despite September’s pullback, the S&P 500’s 13% return this year stands above the index’s historical average annual return. Info tech, consumer discretion, and communication services are still up 35%, 27%, and 40%, respectively. The index is up 20% since its bottom on October 12, 2022. For perspective, September’s selloff isn’t abnormal. History shows that a 5% correction is a regular occurrence.
The underlying economy remains strong. U.S. third quarter corporate earnings are being revised upwards. The Atlanta Fed forecasts third quarter real GDP growth of 4.9%, up from 2.1% for the second quarter. Nine of 11 economic sectors in the S&P 500 are forecasted to have positive earnings growth for the year ahead. Analysts forecast earnings growth for five sectors to be above 20-year historical averages for the next 12 months.
Consumers, which account for three-fourths of GDP, continue to be robust, supported by solid job growth and rising real wages. The unemployment rate continues to hover around a historical low of 3.8%.
Yields on intermediate- and long-term Treasury bonds rose for a multitude of reasons over the third quarter. Most prominent are the continued strength of the U.S. economy and the increase in the premium investors require to hold long-term bonds. The 10-year U.S. Treasury yield jumped from 3.8% to 4.6% - it’s highest level since 2007 – with most of the rise coming in September alone.
Inflation figures have moderated significantly in the United States. The core Personal Consumption Expenditures (PCE) index in August was reported at 3.9% - down from last year’s peak of 5.6%. Still above the Fed’s 2% mandate, but a sustained downtrend towards manageable levels appears to be underway. Shelter continues to be the largest contributor to inflation and should continue to decelerate into 2024.
The Federal Reserve has increased rates at a historically swift pace – the fastest in modern history. The rate hiking cycle appears to be nearing the end and attention is shifting away from rate hikes to rate cuts. The latest Summary of Economic Projections released by the Fed shows committee members anticipate a “soft landing” as the likeliest scenario. However, much uncertainty remains around the path forward for short-term interest rates. “Higher for longer” is now the favorite phrase in financial pundit’s lexicon.
The Fed’s challenge will be navigating choppy waters and knowing when rate cuts are necessary. With a tight labor market, demand could reignite inflation if rates were to be cut prematurely and erase much of the progress made so far. However, keeping rates elevated for too long could cause cracks to emerge. Fortunately, the Fed has the ability to slash rates rapidly should any significant problems appear – a situation that should bode well for high-quality bonds.
What It All Means
There remains much uncertainty about the path of monetary policy going forward. This will likely cause more gyration in the financial markets. But volatility is normal – it’s part of a healthy functioning financial system. Long-term investment returns come in fits and spurts, not all at once. Investing success is ultimately dictated by how one reacts when volatility ensues. In the last 43 years, the stock market has had intra-year double-digit drops 60% of the time. The average intra-year drop was 14%. Three-quarters of those years ended in positive territory.
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