Seasonal weakness. The September Effect. These terms are often used in connection with late summer, during which we historically have experienced the worst-performing months of the calendar (over the last 50 years or so). Just like the weather, market performance has its own “seasons” which are sometimes predictable and repeatable, and September is the only month in the year with a negative average return. This year was no different. The major equity benchmarks all declined during the month (and quarter), with small caps and NASDAQ “leading” the pack and the blue-chip Dow Jones the least bad. The S&P 500 landed in the middle, losing -4.8% during the last month of summer. This September bruising was a continuation of the correction that began in August, just days after the broad indices came within striking distance of the all-time highs set in late 2021 and early 2022.
The strongest headwind to stocks during the month was soaring yields, and investors continue to sell bonds despite the Federal Reserve holding its benchmark interest rate steady. Bond yields, which move inversely to prices, rose dramatically across the entire curve and the most quoted benchmark, the 10-year US Treasury yield, tagged a 16-year high during the month. This selling pressure was driven mostly by the Fed’s interest rate expectations, which can be succinctly described as higher for longer. Those expectations as measured by the “dot plot” showed 0.5% less in rate cuts for next year, which was a departure from earlier plots indicating a more aggressive loosening campaign in the future. Fixed income investors are now pondering if additional rate hikes are coming down the pike and when the Fed will reach its peak for this cycle.
Oil prices continued their surge during the waning days of summer. West Texas Intermediate crude, the regular oil product quoted in the United States, is racing towards $100/barrel. Brent crude, the international version, has soared more than 30% since July. This is an ominous sign for inflation fighters, as rising energy prices could cause inflation data to reaccelerate, which could provide the impetus for the central bank to hike rates further still and keep them raised for longer. Buoyed by the dramatic rise in oil, energy and commodity assets performed well during the month, with the latter gaining 4.7%. It was the only asset class (save cash) that saw positive September returns, and this exacerbated already negative sentiment as rising energy prices tend to mute future economic activity and reduce the likelihood of a soft landing.
US dollar strength also made headlines during the month. The dollar index recorded eleven straight weekly gains in Q3 to reach fresh 2023 highs by the end of September. Given its historical inverse correlation to US stocks (e.g., dollar up, stocks down), this bears watching as continued dollar strength could translate into sustained equity weakness. That said, the dollar gain does reflect expectations that the US economy will continue to show more resilience to higher rates and oil prices than other global economies. While a rampant dollar does pose near-term challenges to individuals and corporations – and equity performance overall – it does also signal that the economy can take the collective macro headwinds in stride, even if the capital markets struggle to maintain valuations.
As we enter the fourth and final quarter of the year, we have several opposing forces at play. On one hand, resilient economic activity still conjures excitement and optimism for the elusive soft landing. Regarding both labor and inflation, the trend remains positive and indicates that the Fed is doing a good job in its attempts to orchestrate a soft landing. Another optimistic consideration is that a seasonally bad period is now in the rear mirror, and historically the last three months of the year have been some of the most bullish for the markets.
On the other hand, we have the powerful headwinds of elevated interest rates, surging oil and dollar prices, and a tech / AI-crazed market that has drifted far away from its July highs, sparking renewed questions and skepticism about AI exuberance and the rally it produced. Nevertheless, the statistically worse month of the year is behind us, and it is the time of the season for crunchy leaves, spooky yard decorations, and hoping October delivers more treats than tricks for investors.