This Might Hurt a Bit

Sep 25, 2023

By Pete Biebel, Senior Vice President, Senior Investment Strategist
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The stock market had been looking a little green around the gills since the beginning of this month; last week its health took a turn for the worse. The S&P 500 Index (SPX), which coughed up nearly 3% last week, had its worst week in six months and touched its lowest level in three months. The NASDAQ Composite Index (COMP) suffered a 3.6% decline. Another measure of the trauma is that the New York Stock Exchange had about 3-½ times as many declining issues as gainers. That was the third-worst weekly ratio this year. Significantly, three of the four worst weekly ratios have come in the past six weeks.

All 11 S&P industry sectors were in the red for the week, ranging from the Healthcare sector’s loss of 1.89% to 6+% losses in Real Estate and Consumer Discretionary. Even Energy, which has been the healthiest sector lately, fell by about 2.7%.

Recent action in the stock market has been a bitter pill to swallow, but there’s likely to be more pain in the near future. With all the virus-related vaxing and jabs in the past couple years, we’ve all heard that “You’re going to feel a little pinch” warning just before they stick the needle in. These little miseries are unavoidable but are for our own good. We know there’s going to be a little pain, but it will all be for the better in the long run. Diagnosing the stock market’s current vitals leads me to conclude that the prognosis isn’t good. We’re likely to have to endure more suffering in the coming weeks, but this too will pass.

The stock market seemed to be as fit as a fiddle a couple months ago. What changed? What circumstances are responsible for this current affliction? About two months ago, in my article “Don’t Bet the Farm,” I described several symptoms of excessive optimism in the market, including a record level of net bullishness among individual investors. Such extremes are a highly reliable contrary indicator. That uber exuberance was likely a sign of an intermediate-term top and possibly the high of the year. Later in the summer, several of the mega-cap tech stocks, which had led the market higher, began to falter. The strongest of the strong were beginning to weaken.

But that was just an early summer tickle in the throat. What really got the market hacking was the flare up in both U.S. Treasury yields and crude oil prices. The nagging and persistent increases in yields and energy prices have acted like a virus, sapping the market’s strength. After setting 15-year high yields in the previous week, Treasury rates continued even higher last week. The 10-year Treasury yield touched 4.5% Friday morning and ended the week near 4.4%, its highest level in 16 years. The potential for “higher for longer” rates got a shot in the arm last week when the Federal Reserve Open Market Committee (Fed) governors indicated that, where they had earlier expected to cut their target lending rate four times next year, they are now more likely to cut rates just twice in 2024.

The price for West Texas Intermediate crude oil was below $70 per barrel and near a one-year low last June as the stock market was in the midst of its springtime rally. At that point, crude had been trending lower for more than a year. Since then, the price of crude oil is up about 35% through Friday’s close at $90.33, including about a 12% increase in just the past four weeks.

Over the past few weeks, there have been a couple other indications that the market’s health was fading. First, small-cap stocks have continued to deteriorate. Last week, the Russell 2000 Index (RUT) was weaker than its large-cap brethren, losing nearly 4%. Strength in small caps was just what the doctor ordered last spring when concentration of leadership was an issue. But higher interest rates could be especially damaging to smaller companies, so as rates climbed in recent months, RUT has declined about 11% from its July high.

Second, as the summer progressed, the market saw improving signs of life in the previously comatose market for initial public offerings (IPOs). Positive post-offering price performance on several big-name IPOs intimated that the IPO market was now alive and kicking. Unfortunately, in recent weeks, several of the most prominent IPO stocks have given up all their early gains and are now making new lows.

With all those negatives, it’s not surprising that the atmosphere for stocks has become more toxic. And the market still faces the threats of an ongoing auto workers strike and a conceivable government shutdown. Another potential threat to the market, which currently lies dormant, is the Fed’s response, or lack thereof, to a steep drawdown in stock prices. Through the years of easy money, the market believed in the concept of “the Fed put.” It was the belief that the Fed would always step in and rescue the market in times of trouble. However, the Fed may now be backed into a corner; it may be unable to ease monetary conditions in the event of a market shock if inflation is still running well above the Fed’s target rate.

The final diagnosis is that it looks like we’re all going to have to live through some more pain before the market is back on its feet. Not to pour salt on the wound, but heightened volatility should also be expected. And that volatility will likely be in both directions, with steep “rally through the vacuum” rebounds following air-pocket mark-downs.

It’s likely that we’re all going to feel a little pinch in the weeks ahead. But forewarned is forearmed. I want to be clear that I am not recommending that any investors take any drastic action. If anything, I would humbly suggest that you might want to hold off on putting sideline cash to work for at least the next two or three weeks. It will be tempting for some more aggressive investors to “buy the dip.” But I suspect that, like a new case of the flu, things are going to get worse before they get better. The current downtrend may not be complete until there’s a greater sense of fear and panic.

SPX closed Friday near 4320, just below both its June and August lows. Unfortunately, there’s not much support for the index between here and the 4200 level, about 3% lower. Coincidentally, SPX’s 200-day moving average is also in the neighborhood of the 4200 level. So far, SPX has given back about one-third of its rally from the March low. A drop to the 4200 area would represent a retracement of about 50% of that four-month rally. Falling to that area would be a painful pinch, but keep in mind that SPX 4200 is still about 20% above last October’s low.

There’s not much on this week’s calendar of economic reports that is likely to make the market forget its pain. Thursday brings the latest update on second-quarter gross domestic product, one of the key measures of overall economic activity in the U.S. But even there, good news might be taken as bad news. Stronger-than-expected economic growth might increase fears of another Fed hike, and consequently weigh on stocks.

Economic Calendar (9/25/23 – 9/29/23) Previous Consensus
Monday 9/25/2023 Chicago Fed National Activity Index, August 0.12 0.15
Dallas Fed Manufacturing Survey, September -17.2 -12.0
Tuesday 9/26/2023 Case-Shiller Home Price Index, July, M/M +0.9% +0.6%
Consumer Confidence, September 106.1 105.9
New Home Sales, August, SAAR 714K 699K
Wednesday 9/27/2023 Durable Goods Orders, August, M/M -5.2% -0.3%
Durable Goods ex-Transportation, August, M/M +0.5% +0.2%
Thursday 9/28/2023 Initial Jobless Claims 201K 211K
Continuing Claims 1,662K 1,675K
Gross Domestic Product, Q2, SAAR +2.1% +2.3%
Personal Consumption Expenditures, Q2, SAAR +1.7% +1.7%
Pending Home Sales, August, M/M +0.9%
Friday 9/29/2023 International Trade, Trade Deficit, August $91.2B $90.1B
Personal Income, August, M/M +0.2% +0.4%
Personal Spending, August, M/M +0.8% +0.5%
Core PCE Price Index, August, Y/Y +4.2% +3.9%
Consumer Sentiment, September 67.7 67.7
Wholesale Inventories, August, M/M -0.1% -0.2%
Chicago PMI, September 48.7 47.9


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