By Jack Kraft, CFA, Investment Strategist
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The third quarter came to a close last week as economic tailwinds from the first half of the year seemed to shift into headwinds. Although economic growth has been better than feared coming into the year, the recent rise in rates, consumer pressures (via higher gas prices and student loan repayments) and union strikes weighed on sentiment during the third quarter.
Last week, the S&P 500 was down 0.7%, while the Dow lost 1.3%. Meanwhile, the Nasdaq bucked the down trend, eking out a small gain of less than 0.1%. Zooming out to the monthly picture, all three major averages were in deep negative territory with the S&P 500, Dow and Nasdaq slipping 4.9%, 3.5% and 5.8%, respectively. The quarterly picture tells a little bit of a better story as the S&P 500 hit a year-to-date high in late July before its quarterly decline of 3.7%. The Nasdaq lost 4.1% during the quarter amid muted performance from big tech. Lastly, the Dow saw the shortest drawdown, falling 2.6% during the quarter.
Diving into quarterly sector performance, the Energy sector seemed to be the only shining star, jumping more than 11.3% amid surging oil prices during the three-month period. Tight supply concerns caused WTI crude to increase to over $90 per barrel after oscillating in the $60- to $80-dollar range for most of the year. The almost 30% rise in crude prices marked oil’s best quarterly performance since the Russian invasion of Ukraine. Higher energy prices have been a net negative for the rest of the market, with nine of the 11 S&P 500 sectors posting negative declines for the third quarter. More defensive sectors underperformed the most, with Utilities, Real Estate and Consumer Staples all falling more than 6.5%.
U.S. dollar strength also garnered attention in the third quarter with the dollar index up over 3.0%, its largest gain since 2022. This puts the dollar above its average trading level in the second quarter and is poised to be more of a challenge for corporations at its current levels. Research firm Jefferies looked at sector performance following strong upward moves in the U.S. dollar and found that domestically focused small caps and S&P 500 cyclicals tend to outperform in the first few months. The Energy sector also tends to benefit in the early stages of a dollar rally, while consumer discretionary, technology and financials see more long-term relative outperformance.
U.S. Federal Reserve (Fed) policy developments also dominated the headlines during last quarter. Central bank presidents’ expectations, measured by the dot plot, showed 50 basis points less in rate cuts for 2024. This reiterated the theme of “higher rates for longer” as investors grapple to predict if additional hikes are needed or if the Fed will be at its peak rate for this cycle. Overall, the U.S. Treasury curve shifted upward and became less inverted (flattened) over the quarter, with the 10-year yield rising by almost 90 basis points to its highest level since 2007. Meanwhile, the shorter dated 2-year Treasury only increased by 20 basis points.
Despite the lackluster third quarter, many investors have been talking about market seasonality. Bespoke Investment Group noted that typically the month of September weighs on stock performance, however, on average, the last three months of the year historically have been some of the most bullish for the market. For example, the last three times the S&P 500 lost more than 1% in August and September, it saw a bounce in October with large rallies in 2011, 2015 and 2022. Furthermore, when the S&P 500 has been up 10% year to date coming into the fourth quarter, the index has been positive 12 out of the last 13 times, with an average gain of 6%.
Although it seems that a confluence of negative themes hit the market in the third quarter, some bullish points remain, in particular on the labor and inflation front, indicating that the Fed may be doing its job to achieve a soft landing. Core inflation numbers (excluding food and energy) remain on a disinflationary trend, while the labor market has shown signs of softening without a large spike in the unemployment rate. Investors will be closely watching the employment data at the end of this week and several inflation updates during the second half of October in order to gauge the additional action policymakers may take.
Over the weekend, a government shutdown was barely avoided as U.S. legislators were able to come to a temporary agreement just before the Oct. 1 deadline. The bill agrees to keep the government funded for the next 45 days until mid-November. This is good news in the short-term as economic data will continue to be reported and avoids unneeded challenges for the Fed as it decides whether another rate hike is needed to control inflation.
Looking ahead to this week, investors will be eyeing the September payrolls report that will be released Friday. Other labor market data releases include the Job Openings and Labor Turnover Survey (JOLTS) and an update on the unemployment rate. Also garnering attention will be reports from the institute of Supply Management (ISM) on manufacturing activity and the services economy. In central bank news, Fed Chairman Powell will participate in a roundtable discussion in Philadelphia.
U.S. Economic Calendar October 2-6
|Monday October 2, 2023||Actual||Previous||Consensus||Forecast|
|8:45 AM||S&P Global Manufacturing PMI Final SEP||49.8||47.9||48.9||48.9|
|ISM Manufacturing PMI SEP||49||47.6||47.8||48.1|
|9:00 AM||ISM Manufacturing Employment SEP||51.2||48.5||48.3||49|
|10:00 AM||Fed Chair Powell Speech|
|Tuesday October 3, 2023||Actual||Previous||Consensus||Forecast|
|7:00 AM||Fed Bostic Speech|
|JOLTs Job Openings AUG||8.827M||8.83M||8.6M|
|Wednesday October 4, 2023||Actual||Previous||Consensus||Forecast|
|6:00 AM||MBA 30-Year Mortgage Rate SEP/29||7.41%|
|7:15 AM||ADP Employment Change SEP||177K||160K||160.0K|
|8:45 AM||S&P Global Composite PMI Final SEP||50.2||50.1|
|8:45 AM||S&P Global Services PMI Final SEP||50.5||50.2||50.2|
|ISM Services PMI SEP||54.5||53.6||53.7|
|9:00 AM||Factory Orders MoM AUG||-2.10%||0.3%||0.3%|
|9:00 AM||ISM Services Employment SEP||54.7||54.5|
|Thursday October 5, 2023||Actual||Previous||Consensus||Forecast|
|7:30 AM||Balance of Trade AUG||$-65B||$-64.6B||$-58.3B|
|7:30 AM||Initial Jobless Claims SEP/30||204K||210K||210.0K|
|Friday October 6, 2023||Actual||Previous||Consensus||Forecast|
|Nonfarm Payrolls SEP||187K||163K||150.0K|
|Unemployment Rate SEP||3.80%||3.7%||3.8%|
|7:30 AM||Average Hourly Earnings MoM SEP||0.20%||0.3%||0.3%|
|7:30 AM||Average Hourly Earnings YoY SEP||4.30%||4.3%||4.1%|
Links to previously published commentaries can be found at benjaminfedwards.com/Latest Investment Insights/Weekly Market Commentary/Market