October Could Kick Off Market Climb, Despite Interest Rates' 16-year High

October Could Kick Off Market Climb, Despite Interest Rates' 16-year High

September 27, 2023

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Here we are in the last week of September. By many measures, the decline that has been experienced since the 2023 high on July 27th at 4607 now seemed to have exhausted the overbought nature of the markets for the year. Since July, the S&P 500 has dropped down to Friday's low of 4302. This is a decline of almost 7%, following a quite ferocious run for the year of up over 15%. This makes me think of basically three things:

  • How much further should the decline go? 
  • What has been the cause of the decline?
  • What should be the focus of equity portfolios when this cyclical decline is over? 

In answering the first question, this is really a pretty tough one. Most prognosticators are calling for a final decline of 4200-4300. I believe that this could be the case, but I really pay a lot more attention to momentum and breadth. Does the decline seem to be gaining speed to the downside or does it seem to be losing its momentum in its move lower? Based on my work on momentum indicators, it appears that we are about "there." The problem is that “there” doesn’t tend to be a line, but rather a mattress that it sort of settles into. This also seems to be fitting with some seasonal measures as well. Instead of explaining, I like to go back to basic pictures that don't really require interpretation, but rather speak for themselves. I begin with the September move. Very clearly the S&P 500 has moved in a quite orderly fashion, lower by 4.3% for the last two weeks alone:

The second point above is the reason for the decline. Every time “the reason” for a decline is a little bit different, but this time it seems fairly clear that the move in interest rates has not only created a new place for money to go to be treated pretty well, but also a required reevaluation of companies, their earnings history, their earnings expectations, and the amount of risk one is willing to assume to make it worth investing in a risk environment to achieve a desired rate of return. According to Ned Davis Research, the interest expense to S&P 500 companies soared to $37.21 per share in Q2 of 2023, up 64.3% verses Q2 of 2022.  I know, that was a lot, but let's take a look at the exact move in 10-year interest rates overlayed on the price of the S&P 500 in the same time period:

I prefer to see it another way, by taking a longer-term period of time and seeing how equity markets respond when interest rates rise over a much longer period. Since it has been so long since interest rates have been at the level they are today, and the speed with which they have risen is virtually unprecedented, the next picture gives a clear picture of the point at which equities started a pullback due to the height of interest rates. I have circled the most recent time period when the S&P 500 rolled over as interest rates rose to a critical level to give added focus to the most recent market action:



In evaluating the focus of portfolios, what seems to be the best way to observe this isn't to simply say that since growth has led for so long, it must be time for value to play catchup. Instead, I feel it best to pay attention to US vs. non-US, value vs. growth, small-cap vs. mid-cap vs. large-cap, and then boil it down on a sector basis. Once the hand is shown and the cards are on the table the places that tend to reverse first, oftentimes are the leaders in the next advance. We really won't know this until it happens. 

What we can examine with clarity is what markets tend to do, with a high degree of consistency, when they have acted the way that our current market is acting. What I mean is that if we are going to try to forecast what could happen next, it would make sense to look for periods of time in history when the markets have acted the way they are currently.  For example, I took the data compiled by FundStrat and put it in a table below. I basically said, going back to 1950 and identifying years where the markets rose January – July, then pulled back during August and September, what did the markets do through the rest of the year? There were 8 instances when this was the case. In every instance the markets finished the year strong, to an average tune of 8%! Not a bad run to the finish line of 2023!

The last point I want to finish with this week is the fact that the last week of September tends to be sort of a dead data week. There are some indicators to go along with the UAW strike and the Government Shut down, but they tend to be less important in evaluating the course of the economy.

After this list, I want to provide what has proven to be my favorite roadmap. This is the election year graph that has been well-compiled by Ari Wald, Chief Technical Strategist of Oppenheimer & Co. It is almost uncanny how the market seems to be following this. What I find particularly interesting is that if this 2023 market acts like the previous 10 election year markets, and if it follows the FundStrat table above, we could have a good last quarter. 

In closing, this week the 10-year US Treasury yield hit a new 16 year high. The fear that is trying to be instilled by the media is the "higher for longer" or the "never again lower" concerns of the interest rate market. What has been forgotten is that the GDP numbers and corporate earnings have been strong while unemployment has remained stubbornly low. These three do not telegraph a slowdown into a recession—at least not yet. I will continue to bring important indicators to your attention, and next week an update on the UAW strike and the US Government shutdown. These all seem to be of some level of economic consequence but are clearly great for political banter. For me, I can't wait for October and hopefully a resumption of the 2023 recovery. As always, we are here to answer any questions you may have.

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