“The discomfort you’re feeling is perfectly normal for someone in your condition,” said the doctor. “But if it doesn’t go away in a few weeks, call me and we might need to reassess.” Investors right now are essentially that patient, reassured by those who have seen many such cases that the fitful unpleasantness they’re experiencing is the routine, perfectly predictable effect of current circumstances. In this case, the time of year. In fact, the S & P 500’s now-6% decline from its cycle peak began almost too perfectly, exactly as the often-tough month of August got underway, continuing into September, the worst month for stock performance through history. As is visible here, the index stalled and then began to chop sideways and down pretty much on schedule relative to the blended average going back to 1950. The strong tendency for this phase to give way to a year-end upturn some time in October is unmistakable, and market observers have been underscoring and modifying this pattern by filtering for years that match present conditions. For instance, when the S & P 500 is down in both August and September but still positive year to date, the index has risen each of the past six times averaging a 9.2% gain, according to Ryan Detrick of the Carson Group. Similar reassuring stats are spit out when accounting for years when the S & P 500 was up more than 10% through July, or for pre-election years. The history is what it is, and the seasonal cadences should be respected as part of an investor’s expectation-setting process. Though, it’s hard not wonder if the “typical seasonal weakness” idea is so well-known and has played so close to the script this year that investors are leaning unduly on it. It’s impossible to answer with confidence. But there’s always the chance that investors are a bit more complacent than they’d otherwise be, waiting things out, selling options to collect premium in what they see as a capped but safe market and not panicking. When sometimes, for a proper correction to run its course, a bit of fear and price-insensitive liquidation are desirable. After last week’s drop, the diagnostic work was underway to determine if the tape was stretched far and fast enough to the downside for a good snapback bounce, or better, to get going. Some indicators were rounding into place. The S & P 500 was oversold by some short-term measures, such as fewer than 15% of S & P 500 stocks sitting above their 10-day average price. The index finally broke an unusually long 102-session streak without a 1.5% or greater daily decline, so that’s out of the way. According to Goldman Sachs trading-desk data, hedge-fund clients as of Friday had reduced their net equity exposure to the 31 st percentile of the past year, largely by adding to short sales. Still, the broad array of tactical indicators of hedging demand and climactic selling aren’t fully apparent. Not that everything needs to line up perfectly, but it helps. Key technical support area The S & P 500 finished the week right on a hoped-for support area, the August low and June breakout level, though many chart watchers see a good chance of a test of 4,200 (down another 2.8% from Friday’s close), which is the 200-day average and the top of the previous longstanding trading range. Aside from seasonal ebb and flow, there’s always a specific litany of issues that accompanies every appreciable market pullback, whether as cause, excuse or coincidence. This time it’s largely the breakout in bond yields to new cycle highs, abetted last week by the Federal Reserve’s clear message that it intends to keep rates somewhat higher for longer than central bank officials and the market had previously assumed. Wall Street is correctly consumed with the question of whether the consumer and broader economy can handle the 10-year Treasury well above 4%, 30-year mortgage rates of 7.5% and high-grade corporate debt costs near 6%. The signals are mixed, the current data still implying resilience in labor markets and spending, with some fraying around the edges of the trends. Fed Chair Jerome Powell saying that we’ll only know if policy is restrictive enough if the economy shows the effects by slowing appreciably was perhaps more candor than traders were prepared to accept. Still, it might come as a surprise that last week the 10-year Treasury yield was up a mere 11 basis points to 4.43%, the 2-year note gaining just 8bp to 5.11%, Sure, these are 16- or 17-year highs, but the incremental moves weren’t so jarring as the near-3% drop in the S & P 500 might’ve implied. It’s also worth remembering that in late 2022 it was commonly thought 10-year Treasurys above 3% would be tough for the equity market to surmount, but under the right conditions, new equilibrium points can be established. Big picture, the backdrop is largely as it was: The Fed remains either done or nearly so with tightening, inflation is dropping faster than the economy is weakening so far. And the effort by the Fed last week to “take away” prospective rate cuts penciled in for the second half of next year is almost too abstract and premature an exercise to use as a basis for allocating capital. Grappling with higher Treasury yields Ed Clissold, chief U.S. strategist at Ned Davis Research, sees the market metabolizing the sharp shift in yields in a rather rational way, avoiding victims of higher funding costs such as smaller bank-dependent companies while bidding up self-financing secular growers. “We have been asked why higher interest rates have not impacted the stock market. By some measures they have. This is the third weakest start to a bull market since World War II,” Clissold said, adding that “5.5% T-bill yields mean investors are comfortable keeping money in cash and then focusing on companies that can grow much more than the risk-free rate.” That makes sense for sure, though it has meant that the equal-weighted S & P 500 is up only 1% this year and has tentatively broken a multiyear uptrend, while small-cap stocks are suffering worse still. Along with surrendering their technical uptrends, though, the indexes of the typical stock or smaller ones have again grown less expensive – one of the jobs of a pullback, along with cooling off investor sentiment and positioning. If someone is complaining both that the S & P 500’s performance has been too narrowly driven by the largest seven growth darlings and that the index is egregiously overvalued, this person is effectively griping about the same thing. And even for the market-cap-weighted S & P 500, the forward P/E is down from nearly 20 to 18 since late July, as prices have fallen, and analysts’ forecasts have continued to plod higher. For as much as the prevailing narrative has turned to “an expansion imperiled by punishingly high rates,” it pays to recall that the economic storyline has had a few twists this year alone: We entered 2023 with an unprecedented consensus predicting recession, then after hot January data the fear was overheating that would hasten a 6% fed funds rate. In March, the regional bank mini-crisis brought “credit crunch” and “Fed is finished” declarations, followed by an impassioned embrace of the soft-landing scenario just as stocks peaked in July and pressure from oil and rates tested such assumptions. This doesn’t mean what comes next is clear. But it’s good to keep in mind that markets and the economic discourse frequently overshoot in the short term, while we wait to see whether this seasonal discomfort fades as the calendar turns.
