Food for Thought

Sep 11, 2023

By Pete Biebel, Senior Vice President, Senior Investment Strategist
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You can take this with a grain of salt, but I think the stock market is going to be in a pickle for the next month or two. Yes, the indices all had a nice rebound coming into the Labor Day holiday weekend, but those gains were low-hanging fruit. Equities had been recovering from a steep sell-off in August and the market typically rallies into a long weekend, so the run-up into the holiday weekend was easy as pie.

But the proof is in the pudding. So far, post-holiday trading has left a bad taste. The NASDAQ Composite Index (COMP) lost nearly 2% last week. The S&P 500 Index (SPX) fell 1.29% net through last week’s four sessions. Both COMP and SPX were down on the first three of the four days; and both are now showing net losses over the past five weeks. What is perhaps hardest to swallow about the weakness is that a couple stocks that had been the apples of the market’s eye in recent months have been dropped like a hot potato. Semiconductor chip manufacturer Nvidia Corp., which is widely known to have been one of the best-performing stocks this year, fell more than 6% last week. And Apple Inc., the largest stock in the land, was nearly as bad, falling almost 6%. That loss included a one-day decline of nearly 3% on news that China had ordered some of its government officials to not use iPhones at work.

Throwing a little salt on the wound, the poorest-performing category in the market lately has been small-cap stocks. As the market rallied through the first half of the year, the extreme concentration of leadership was a source of concern. A relative smidgeon of mega-cap tech stocks had accounted for the bulk of the market gains. But through the speculative rush of June and July, the previously lagging small-cap stocks went bananas. Surely this broadening of participation meant we were in a new bull market, right? Sadly, that pie-in-the-sky enthusiasm for small-caps quickly faded. The Russell 2000 Index of small-cap stocks (RUT) fell more than 7.5% through the first three weeks of August. And while that index did rebound some in the pre-holiday week, RUT gave back all of that recovery in the four sessions last week.

Only two of the 1 S&P industry sectors (Energy, +1.44% and Utilities, +0.86%) managed to finish the week with net gains. Among the worst of the sectors that couldn’t cut the mustard last week were Basic Materials (-2.4%) and Industrials (-2.9%).

It doesn’t require a very sensitive palate to identify several of the main ingredients in the recipe for this stock market flambe. Higher interest rates and higher energy prices, combined with weakness in both small-caps and some of the glamour stocks, is a mix that has been hard for the market to swallow. The 10-year Treasury yield, which was stuck between about 3.3% and 3.7% through last spring, shot higher through the summer and hasn’t been below 4% since early August. It has been as high as 4.33% in recent weeks and ended last week at 4.27%. These are the highest 10-year rates in more than 15 years. And higher rates may be a hard nut to crack. To fund our huge fiscal budget deficits (You can’t have your cake and eat it too.), the Treasury will need to issue something around one trillion dollars of debt in the coming months. So even in an environment with slowing inflation, we still face the likelihood of higher for longer interest rates.

If not for higher energy prices, overall market performance last week would have been worse. The prices of crude oil and energy stocks are like two peas in a pod. After wallowing around $70 per barrel from May to July, crude prices have chugged steadily higher in recent months. That has enabled the Energy sector, which had lagged the market earlier this year, to rally nearly 20% in just the past 2 ½ months. Last week’s gain of about $2 per barrel lifted crude to its highest level in nearly a year and helped the energy stocks bear fruit in an otherwise barren week. And as is the case with interest rates, fundamental factors, like Saudi Arabia extending their production cuts, suggest we shouldn’t expect a reversal in the current trend anytime soon.

Perhaps the newest of the bearish factors is that the market seems to have lost its taste for the relative handful of mega-cap tech stocks that were the clear market leaders early in the year. It was just a few months ago when market commentators cooked up the term “magnificent seven” as a reference to this very small group of very large stocks whose gains had been responsible for nearly all of SPX’s gains in the first half of the year. But, where those stocks had been the market’s bread and butter early in the year, last week’s performance may indicate that they are now the forbidden fruit. We’ll be watching this group in the weeks ahead. If their performance is just half-baked, it could be a recipe for trouble for the overall market.

One other potential concern is simmering on the back burner. Another U.S. debt ceiling deadline looms at the end of the month. There has already been some indication from hardline Republicans that they are willing to resort to aggressive tactics to get spending concessions. Though these negotiations typically wind up with at least a stop-gap solution, if things come to a boil, there is the risk of a government shutdown.

The overriding and ongoing concern for the market is whether earnings have bottomed. The first two quarters of the year saw earnings that, though better than expected, were still earnings decreases. The current level of SPX is about 19 times the per-share earnings of its component companies. That’s already a little on the expensive side, but it can be justified if earnings are going to be maybe 5% or 10% higher next year. Over the next month, analysts will watch company guidance and tweak their earnings estimates in advance of third-quarter earnings, which will begin to be reported in October. If there is growing evidence in the weeks ahead that earnings have bottomed and that third-quarter results will show an increase, then the market will be able to ignore some of the factors above. However, if further declines become the expectation, it will be a pretty bitter pill to swallow.

SPX closed Friday near 4457, about in the middle of its range for the past month but back below its 50-day moving average. A gain of just 0.5% would be enough to get the index back above that average. A gain of 1% or more, putting SPX back above the 4500 level, would be encouraging for the bulls and help eliminate the sour taste of last week’s loss. However, a decline of just a bit more than 0.5% would drop SPX below last week’s low and could very well trigger an acceleration in the descent.

The menu of economic reports this week offers several tempting entrees for analysts to sink their teeth into. Following a light appetizer on Tuesday, several meatier courses will be served on Wednesday (consumer price index) and Thursday (initial jobless claims and producer price index). If any of those reports come in much worse than expectations, it will likely cause a bit of market indigestion.

Because the Federal Reserve’s Open Market Committee is scheduled to hold another of their policy meetings next week, Fed officials will be in quiet mode this week. The market seems highly confident that the Fed will not raise its target rate at the September meeting, but Fed-fund futures are still indicating about a 40% chance of a November hike. One off-the-menu dish that could add some spice to the market’s diet later this week is any progress or lack thereof on a potential strike at one or more U.S. car companies by the United Auto Workers union.

Economic Calendar (9/11/23 – 9/15/23)



Monday 9/11/2023 No Reports Scheduled

Tuesday 9/12/2023 NFIB Small Business Optimism Index, August



Wednesday 9/13/2023 Consumer Price Index, August, M/M



CPI ex-Food & Energy, August, M/M



CPI ex-Food & Energy, August, Y/Y



Thursday 9/14/2023 Initial Jobless Claims



Continuing Claims



Producer Price Index, August, M/M



PPI ex-Food & Energy, August, M/M



PPI ex-Food & Energy, August, Y/Y



Retail Sales, August, M/M



Retail Sales ex-Vehicles & Gas, August, M/M



Business Inventories, July, M/M



Friday 9/15/2023 Empire State Manufacturing Index, September



Import Prices, August, M/M



Export Prices, August, M/M



Industrial Production, August, M/M



Consumer Sentiment, September




Links to previously published commentaries can be found at Investment Insights/Weekly Market Commentary/Market