Stocks logged another month of gains in August, but once again September, it has started off with a sharp sell-off.
The S&P Composite 1500 rose 2.0% in August, better than July’s 1.6% gain. Large caps outperformed, offsetting losses in mid- and small caps. For the month, The S&P 500 advanced 2.3%, the Mid-Cap 400 lost 0.2% and the Small Cap 600 fell 1.9%.
After closing out August on an up note, with a solid 1% advance, stocks began the month of September with a sharp 2.2% sell-off and closed out the week down 4.3%. The business media attributed the plunge to renewed fears of an approaching economic slowdown.
Yet, the market has recovered quickly, making back nearly all of its losses. Stocks ended this week up 4.0%. The next potential catalyst is the FOMC’s decision on interest rates on Sept. 18. Market watchers see either a 25 bp or 50 bp cut as a coin flip. Financial markets want a 75-100 bp drop in rates by year-end.
September is traditionally a tough month for stocks. According to S&P Dow Jones Indices (via Morningstar), the S&P 500 has posted an average decline of 1.2% and generated positive returns only 44.3% of the time.
Currently, large caps remain in an uptrend, even excluding the megacaps; while midcaps are rangebound. Small caps have recently broken out of their trading range to the upside, but they have been struggling to hold onto those gains.
One-Year Chart of the S&P Composite 1500
Megacaps vs. the Rest of the Market. In August, the 20 largest stocks by market cap rose 2.07%, according to my estimates. With their total market cap weight of 42.2%, they accounted for 0.87 percentage points (PP) of the Composite 1500’s 2.04% gain.
Within those 20, the Mag 7 accounted for 0.04 PP of the S&P Composite 1500’s gain; so the remaining 13 megacap stocks added 0.83 PP. By my estimates, the Mag 7 produced a market-cap weighted gain of just 0.2%. Three of those stocks posted positive returns—Meta Systems (Meta), up 9.8%, Apple (AAPL), up 3.1%, and NVIDIA (NVDA), up 2.0%. The remaining four had negative returns ranging from –0.3% to –7.7%.
By comparison, the remaining 1480 or so stocks in the S&P Composite 1500 index, which accounted for 57.8% of its total market capitalization, rose 2.02% and contributed 1.17 PP to the Composite 1500’s overall 2.04% return.
Sectors. By sector, Consumer Staples, Real Estate, Healthcare, Financials and Utilities were the top performers in August. Most are considered “risk-off” because their businesses typically hold up better in an economic slowdown. The bottom two performers were Consumer Discretionary and Energy, which posted losses of 1.1% and 2.8% respectively. Consumer Discretionary’s losses were entirely due to the declines of 4.5% in Amazon (AMZN) and 7.7% in Tesla (TSLA), which are also components of the Mag 7. Excluding those losses, the rest of the sector posted a combined, market cap weighted gain of 0.8%. On the other hand, ExxonMobil (XOM), a mega cap, posted a 0.5% decline, less than the rest of the Energy sector; so that sector’s loss, excluding XOM, was wider at 3.6%.
Fixed Income markets slightly underperformed equities, advancing 1.4% in August, as measured by the ICE US Broad Market Index. By sector, Treasurys rose 1.3%, mortgages 1.6%, investment grade corporates 1.5% and high yield corporates 1.6%. Municipal bonds earned 0.8% for the month. August marked the fifth consecutive month of gains for bonds.
Longer duration securities outperformed again. Among U.S. Treasury ETFs, the 20+ Year (TLT) rose 2.1%; the 7-10 year (IEF) gained 1.4%, the 3-7 year (IEI) added 1.2%, and the 0-3 year (SHY) earned 0.9%.
So far in September, the rally in bonds has continued. Treasurys gained 1.9% through Sept. 13; mortgages 1.8%, corporates 1.8%, but high yield corporates have lagged, rising 0.7%. (High yield bond performance is typically more closely correlated to the equity market, which is down 0.5%.) Gains on longer duration bonds have also accelerated, further outperforming their broader sector averages.
Inflation. The month-to-month change in headline CPI was 0.12% in July and 0.08% in August, essentially flat and the two best readings of the year. Core CPI increased 0.07% and 0.25%, respectively. The July and August A3MoAvg rates are 1.3% for July and 0.9% in August for headline CPI, and 1.6% and 1.8% for core. According to the views of market participants, these low readings support the start of Fed easing.
The solid readings on CPI inflation were consistent with those of the personal consumption expenditures (PCE) price index, which increased 0.16% in July, compared with June’s 0.06%. The A3MoAvg increase in headline PCE was 0.90%, down 0.43 PP from 1.33% in June. The A3MoAvg rate for core PCE was 1.72%, down from 2.10% in June.
A key driver of lower inflation in recent months has been a steady and fairly sharp drop in energy costs, which declined 11.7% in June and 15.8% in July (on an A3moAvg basis), according to the PCE index, and 3.9% in August and 10.0% in September on the same basis, according to the CPI. While decreasing demand, especially in China, has precipitated this decline, it seems unlikely that that the cost of energy will continue to drop at double-digit rates for very long.
The decline in energy costs has been mostly offset by increases in other services costs, especially shelter, which is still rising at a better than 4% annualized rate in both the PCE and CPI surveys. If and when energy costs stop falling, we could therefore see another modest spike in inflation.
The Federal Reserve Bank of Cleveland has two alternative measures of inflation which suggest that the underlying inflation rate may not be quite as good as suggested by the headline and core readings. Its median CPI measure, which tracks the annualized one-month change in the median price of all goods and services included in the CPI, shows inflation running at 4.2% in August. That is down from a peak of 7.1% in February 2023, but still above the average of 2%-3% recorded prior to 2022. Its 16% trimmed–mean CPI is a weighted average of one-month inflation rates of CPI components whose expenditure weights are below the 92nd percentile but above the 8th percentile. That measure shows inflation running at 3.2% in August, about even with the change in core CPI. The 16% trimmed mean measure is below its peak of 7.2% recorded in Sept. 2022, but above its pre–2022 range of 2%-3%.
The Cleveland Fed asserts that both the median CPI and 16% trimmed-mean CPI are better measures of the underlying level of price changes and therefore of current monetary inflation. The median CPI now shows that inflation for most goods and services is still running well above the current pace of headline and core inflation. These indicators show that inflation for most goods and services continues, so the Fed should resist the pressure (or temptation) to lower the Fed Funds target rate quickly.
Commodity prices mostly fell in August. The CRB index declined 0.4% after June’s 4.3% drop. Oil futures prices declined mostly at mid-single digit rates. Gasoline fell 14.2%, but natural gas futures prices rebounded 4.4%, after July’s 21.5% plunge. Key agricultural commodity prices rose on average. Precious metals prices ended month modestly higher.
The Treasury Yield Curve. The decline in U.S. Treasury yields across the intermediate to long maturities continued in August and so far in September. Yields from 6-months to 30-years fell by 25 bp on average in August and by another 29 bp through September 12. The greatest declines in yields have been in the one to three year maturities, down 35 bp in August and 36 bp so far in September. The 10-year yield has declined steadily to 3.66% on Sept. 13, the lowest in more than a year.
Mortgage Rates and the Fed. The average 30-year mortgage rate, which is set off the 10-year Treasury yield, fell 15 bp to 6.20% last week, according to Freddie Mac, the lowest since February 2023.
The CME’s Fed Watch tool estimates a 55% probability of a 25 bp cut in the Fed Funds target rate and a 45% chance of 50 bp cut at the FOMC’s September 18 meeting. According to my estimates, the tool implies a 49% probability of another 25 bp cut and a 51% chance of a 50 bp cut at its November 7 meeting. It also implies a 38% chance of a follow-on 25 bp cut and a 62% probability of a 50 bp cut at its December 18 meeting. All told, the futures market implies a 10.2% chance of three consecutive 25 bp cuts, a 75.5% chance of cuts totaling 100-125 bp and a 14.3% chance of three consecutive 50 bp cuts by year-end. Although the economy is slowing, those implied probabilities strike me as aggressive and therefore unlikely.
Those probabilities are presumably a primary catalyst for the continuing rally in bonds. If I am correct in my assessment of the outlook for Fed Funds rate cuts, then bonds may very well give back some of the gains that they have made over the past five months.
The Economy. As noted, the renewed sell-off in equities in early September was reported to have been precipitated by concerns of an accelerating slowdown in the economy. Yet the data remains mixed. There are one or two more signs of an approaching economic slowdown, but some economic datapoints still show surprising strength.
GDP. 2024 second quarter real GDP rose at a 3.0% annualized rate from the first quarter, according to BEA’s second estimate. That is up from 2.8% in the advance estimate and higher than the 1.4% increase reported for 24Q1. The increase was driven by personal consumption expenditures, up 2.9% annualized; a 7.5% increase in gross domestic private investment and a 2.7% increase in government expenditures.
As of August 8, FRB Atlanta’s GDP Now tool estimates 24Q3 annualized real GDP growth of 2.5%, down from 2.9% a month ago. The FRB New York’s Fed Now tracker pegs annualized 24Q3 real GDP growth at 2.6% (up from 2.5% at the end of August. Also as of late August, the consensus of Blue Chip forecasters (via the Atlanta Fed) projects 24Q3 GDP growth of 1.5% to 2.3%, with a mean estimate of 1.8%.
Personal Income rose 0.31% in July and at an annualized three-month average (A3MoAvg) rate of 3.7% (up from 3.3% in June). The A3MoAvg growth of employee compensation was 4.6%, up from June’s revised 3.9% rise.
Excluding employee compensation, personal income from other categories increased 0.27%, higher than the revised 0.11% in June. The A3MoAvg rate declined from 2.3% to 2.1%.
Disposable income growth was also faster, up 0.26% in July vs. 0.15% in June. The A3MoAvg rate increased from 2.8% to 3.0%. Personal consumption expenditures rose 0.53% in July, faster than June’s 0.32%. The A3MoAvg rate of personal consumption expenditures increased from 4.5% to 5.7%. With consumption still rising at a faster rate than income, the personal savings rate declined to 2.9% in July from 3.1% in June.
July’s personal income gains were stronger than June’s and at a level that would likely fuel higher inflation, if they continue. The gains were markedly slower than those reported earlier in the year, but income and spending are still rising at a rate that would likely support an annual inflation rate of 3% or higher.
Jobs. Employment growth continued to slow. The Bureau of Labor Statistics reported that payroll employment in August increased by 142,000 positions, higher than July’s downwardly revised 89,000 increase. The three month moving average of monthly increases slowed to 116,000 positions, down from 141,000 in July and the lowest since the onset of the pandemic.
Household employment increased by 168,000 positions, up from 67,000 in July. The three-month moving average improved to 117,000 positions, reversing July’s 75,000 decline. The labor force participation rate held steady at 62.7%. The unemployment rate eased to 4.2%, from 4.3% in July.
On a rolling 12 month basis, household employment has declined by 62,000, while payrolls are up 2.36 million.
August’s average hourly wage increased 0.40% to $35.07, faster than July’s 0.23%. On an A3MoAvg basis, the average hourly wage rose 3.8% vs. July’s 3.7%. Average weekly hours rose by 0.1 to 34.3 hours. Thus, average weekly earnings rose 0.7%, reversing July’s 0.1% decline. The A3MoAvg growth rate of weekly earnings was 3.8% in August, up from 2.5% in July.
The change in non-farm payrolls of 142,000 was modestly below the consensus estimate of 155,000. Although the slowdown in hiring has been expected for quite some time now, some economists have been expressing concerns that the labor market will weaken at an accelerating pace going forward and are therefore calling for the FOMC to lower the Fed Funds target rate by 50 bp at its meeting next week, rather than 25 bp. This chorus of aggressive rate cut calls has arisen even though employment growth has remained stronger for much longer than most economists have anticipated. Despite its 50 bp point rise over the past year, the unemployment rate remains well below the 5% level that most economists associate with full employment. Even with the recent slowing of payroll employment growth and that 0.5 PP rise in the unemployment rate, increases in wage rates have continued to run around 4%, which is well above the Fed’s targeted inflation rate. Despite concerns that the slowdown will accelerate, there still seems to be enough tightness in the labor market for the Fed to ease at a measured pace for now.
The seasonally adjusted four-week moving average of weekly unemployment claims (from the Dept. of Labor) has declined from a peak of 238,500 on June 29 to 230,750 on Sept. 7. Similarly, the seasonally-adjusted four-week moving average of continuing claims was 1.85 million on Sept. 7, down from a peak of 1.95 million on July 6. On a YOY basis, the percentage increase in 4-week SAAR average claims has slowed steadily throughout 2024 from 12.2% on January 6 to 2.5% on Sept. 7.
Job cut announcements, as estimated by Challenger Gray & Christmas, jumped to 75,891 in August from 25,885 in July, but were up only 1% YOY. So far this year, announced job cuts are down 3.7% vs. 2023. Even so, announced hiring plans of 79,700 YTD are down 41.4% vs. 2023.
The ISM’s August Manufacturing PMI was 47.2, up 0.4 PP from 46.8 in July. Although this was the fifth consecutive reading below the neutral level of 50, the increase vs. July signals a slower rate of contraction. Yet, the index for new orders fell to 44.6 from 47.4, the fastest rate of contraction in four months, with nearly two-thirds of respondents expressing concerns about the decreasing pace of new order activity.
The ISM’s August Services PMI increased slightly to 51.5 in August from 51.4 in July. Business activity continued to expand, but at a slower rate. The pace of new order growth picked up a bit, but backlogs contracted. Sentiment among respondents was mixed, but the overall figures suggest that the services sector remains resilient. The sector continues to expand, albeit at a modestly slower pace than a year ago.
Industrial production fell 0.6% in July and June’s estimated increase was cut in half to 0.3%. All three major market groups—final products, nonindustrial supplies and materials—posted declines. Among the three major industry groups—manufacturing and utilities declined, but mining was flat. The YOY pace of industrial production which had briefly turned positive in May and June, now shows a decline of 0.2%. Capacity utilization fell 0.6 PP to 77.8% in July. Industrial production activity has been mostly flat for the past year, which is impressive given high interest rates. A key question is whether the sector will begin to expand again as interest rates ease.
Housing. The SAAR of existing home sales increased 1.3% month-to-month, the first increase in five months. In June, existing sales declined 4.5%. YOY, the SAAR pace of existing sales was down 2.5%. YTD, actual sales are down 2.0%.
The median price of existing homes sold declined 1.0% in July (from June) to $422,600. YOY, the median price is up 4.2%. Similarly, the average price decreased 1.0% month-to-month to $559,500, but is up 5.1% YOY. A shift in mix to higher priced homes explains much of the continuing rise in house prices..
Unsold inventory of 1.33 million units rose 0.8% month-to-month and 19.8% YOY. The supply of inventory on the market eased to 4.0 months of sales from 4.1 months in June. These are the highest inventory levels since before the pandemic.
First-time buyers accounted for 29% of sales in July, flat with June, but up from 26% a year ago. Average days on the market were 24 vs. 22. All-cash transactions were 27% of sales, up from 26% last year. Individual investors and second home buyers accounted for 13% of sales, down from 16% MTM and YOY.
The NAHB’s Housing Market Index, a measure of builder sales sentiment, dropped two points to 39 in August (from July). Among its components, sentiment about current sales declined two points to 44; buyer traffic also dropped two to 25; but the outlook for sales six months out increased a point to 49. Readings below 50 indicate that sales are expected to contract.
The SAAR of single-family housing starts fell 14.1% to 851,000 units in July, from June’s upwardly revised estimate of 1.0 million. The SAAR of single-family permits decreased 0.1% to 938,000. The SAAR of single-family completions was estimated at 1.05 million, essentially unchanged from June.
YTD, total housing starts are now down 4.9% vs. last year, with single-family starts up 11.4% and multi-family starts down 34.9%. Single-family completions are up 1.7% YTD.
The estimated SAAR of new home sales increased 5.6% to 739,000 in July (from an upwardly revised 668,000 pace in June). YTD, estimated new home sales are up 2.6%.
The annualized pace of new home sales has been stable this year, as has housing inventory. With the recent upward revision in sales, the estimated months of supply has fallen to 7.5, below the average of 8.4 since the Fed began raising interest rates, but still above the long term average of 6.0. With mortgage rates now down 90 bp from April highs, the sales pace could be sustained or perhaps even increase in the months ahead.
The Fannie Mae Home Purchase Sentiment Index (HPSI) rose 0.6 points in August (from July) to 72.1. The increase was driven by lower expected mortgage rates and lower expected house price appreciation. Despite the anticipated improvement in affordability, only 17% of consumers say that now is a good time to buy, unchanged from July, and 83% say it’s a bad time, up 1 PP. Even so, continuing declines in mortgage rates should raise home purchase sentiment further in September.
The Conference Board’s Consumer Confidence Index rose 1.4 points to 103.3 in August, from an upwardly revised 101.9 in July. The present situation component rose a point to 134.1, while the expectations component added 1.4 points to 82.5. Consumers were more confident about current business conditions, but less confident about jobs. They were also more confident about the six month outlook for business conditions and jobs; but less confident about the outlook for income. Two-thirds of consumers still say that a recession is likely.
The Long-Term Bias Remains to the Upside, But Near-Term Risks Are Elevated. Stock market volatility has picked up considerably over the past two months. It spiked higher briefly in early August before settling down at month’s end. It spiked again in the early September sell-off, but not nearly as high as in August. Stocks have already recovered nearly all of what they lost a week ago, whereas August saw a second leg down before recovering at month’s end.
As of September 13, the chart of the broader market shows a triple top. While stocks could conceivably move higher from here to new all-time highs, it seems more likely to me that we will at least revisit the August lows first.
Next week’s big event is the FOMC’s decision on the target Fed Funds rate. Futures markets pitch this as a coin toss between a 25 bp cut and a 50 bp cut. I have argued here that data do not support a 50 bp cut. Yet, it is clear that the five month rally in fixed income markets (and associated drop in yields) has raised expectations of significant cuts—perhaps not 50 bp at this meeting, but the equivalent of 100 bp—125 bp of cuts by year-end. If I am right and the Fed takes a measured approach to cutting rates, bond investors could be disappointed. In that case, bond yields would rise and stocks would probably decline.
September 15, 2024
Stephen P. Percoco
Lark Research
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© 2015-2024 by Stephen P. Percoco, Lark Research. All rights reserved.
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