The month of September lived up to its dark reputation as the historically worst month of the year. As you can see on the performance chart below, it was the worst month so far this year by more than double. And when combined with August, following a robust first half of the year, it turned Q3 into somewhat of a reality check. Investors seemed to sense that a market rally driven higher by 7-8 large cap tech stocks, may not last forever.
At the end of the first week of October (when I’m writing this), the stock market is well into its second correction of the year (see 1yr SPX chart). The Feb/Mar pullback associated with the regional bank crisis took the S&P 500 Index (SPX) down -7.75%, before the rally resumed. The current correction began on August 1st. So far, peak to trough, the SPX is down -8.5%. As we have written in August and in
September, the current market decline is a garden variety market pullback unless it crosses the major support level of 4200 – our line-in-the-sand that if violated, would characterize our pullback as something worse. So far, so good.
Labels are not applied to markets in the moment – only in retrospect. The Feb/Mar pullback was driven by the regional bank scare (not really a crisis looking back). The current market decline may end up being labeled a pullback driven by a significant rise in yields in the bond market. Yields have likely been driven higher recently by investors finally accepting that the Fed’s tightening cycle is not yet over. It has taken a while for “Higher For Longer” to be discounted into securities pricing. This all presupposes that price support levels on the major market indexes hold in the weeks ahead. If support is violated, it is because prices have not held up and different labels will be applied to the current period – “correction” (declines >10%), “start of bear market”. We’ll cross that bridge if we get there.
It is axiomatic that the economy drives market pricing. It is enigmatic that market pricing precedes economic reporting. The study of the economy, macroeconomics, offers little in the way of timing tools of market analysis. But it so important to watch to changes in the economy against the message the market is sending (recent Morning Notes) to try to discern changes in market trend.
I believe the economy is on a knife edge between growth and contraction over the near term (weeks). If it falls to the growth side (scenario A), the Fed will raise, yields will rise, the economy will ultimately feel that, and recession will likely ensue – call it second half 2024. If the economy falls to the contraction side of the knife’s edge (scenario B), I think it means the tightening over the past 18 months is having its lag effect and recession early in 2024. There is macro evidence for both scenarios but overall, the macro evidence does lean toward scenario A.
Let’s connect the market message to the macro scenarios. Simply put, a market rally off of support would dovetail nicely with scenario A. If support fails – scenario B. Both scenarios end in recession and I don’t think I’m a good enough risk manager to finesse the near term rally of scenario A. We stay cautious then with the expectation of looking foolish in any year end rally.
Sources: Addepar, BCA Research, Bloomberg, Ned Davis Research
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