Markets retest lows as growth concerns rise

Thoughts

• Equity markets fell to their weakest level in two months, as the rally enjoyed since mid-June fades on persistent inflation pressure and rising global growth concerns ahead of a pivotable FOMC meeting. Additionally, high-profile negative earnings preannouncements served as a reminder that 2023 estimates are likely to be revised lower. Sentiment and market momentum have turned decidedly negative, increasing the likelihood that we retest the June lows (4% down from here). Interest rates are higher, with the 10-year above 3.50% for the first time since 2011 and the yield curve is at its most inverted level since 2000.
• Beyond the economic and earnings slowdown, investors also face several technical factors that will impact near-term returns. September is the weakest month on the calendar historically, with the second half of the month particularly weak as management teams tamp down expectations for the following year. Share repurchases enter a blackout period, impacting demand for shares at a time when fund managers are holding their largest cash levels since 2001. With two weeks left in the quarter, the S&P 500® Index is on pace for the sixth-worst performance on record through three quarters, trailing only 1974, 2001, 2002, 1931, and 2008. While seasonality is a headwind in the near term, the fourth quarter is traditionally the best performing quarter, particularly following midterm elections.
• When CPI was released last week, we saw the worst day in the market since the beginning of the pandemic. Due to current negative indicators including high inflation and the Fed’s upcoming rate announcement, global economic growth concerns and earnings expectations, we expect to see a continued negative pattern in the near-term with a potential bounce back in Q4. It will not take much good news to light a fire under the market but we don’t expect that good news to come in the next few weeks.

News

• Investors continue to shift their expectations for Fed policy ahead of next week’s FOMC meeting. Following the CPI release, the terminal (peak) Fed Funds rate jumped to 4.5% in May, up from less than 4% two weeks ago. In the past month, the odds for the September meeting went from a 50% chance of a 0.50% hike to a 20% chance of a 1.00% hike, though a 0.75% hike is the most likely given recent commentary. Treasury Secretary Yellen noted that “Inflation remains a problem, and obviously is of tremendous concern to Americans,” noting that the “prime job here rests with the Federal Reserve.”
• Growth expectations continue to moderate, with the Atlanta Fed’s GDPNow model now predicting just 0.5% growth in the quarter versus 1.3% last week, setting the stage for a potential third-straight negative quarter. Economic sentiment among CEOs fell for a third straight quarter on recession fears, while the NFIB small business optimism index below the 48-year average for the eighth consecutive month in August, with profit expectations lowest since the pandemic. World Bank warned on Thursday that the global economy may face a recession triggered by aggressive central bank tightening that may not be sufficient to combat inflation. Global central banks are withdrawing monetary and fiscal stimulus at a pace and level of coordination not seen in roughly 50 years, predicting 2023 global growth at just 0.5%.
• Anecdotal news this week foreshadows a difficult earnings outlook as the third quarter comes to a close. September is the seasonally weakest month of the year, largely because companies use Wall Streat conference season to dampen expectations for the following year, and the current macro uncertainty increases that likelihood. Beyond revenue and margin uncertainty, domestic earnings will be impacted by the strong dollar through competitive and conversion headwinds, with the 19% rally in the dollar index over the past year, potentially impacting S&P® 500 earnings by more than 5%. Also, the new 15% corporate minimum tax is a 1.4% headwind, per Strategas.

What to Watch

Wednesday’s FOMC announcement will be the primary focus of investors, with Chair Powell’s press conference particularly important. Economic data include housing starts on Tuesday, existing home sales on Wednesday, leading indicators on Thursday, and PMI data on Friday.