Historically speaking, September is the worst month for the stock market. October usually gets the rap for the worst month, but October is typically where the market finds a bottom and rallies into year-end. To illustrate, here’s a chart that shows monthly averages going back to 1928.
You can see it’s not even close, though it is always important to remember these are averages. There are no guarantee that any given year will be negative. That said, with historical downside, comes increased volatility. We have certainly seen volatility increase over the past month.
That spike in August was the day the Dow was down 1000 points. The same day we had a weak jobs number and an increase in fear that the Federal Reserve is now behind the curve. That bout of severe volatility left as quickly as it arrived.
But given that September is historically the worst month of the year and that we are seeing a slowdown in the economy, what should you expect for the last few months of the year?
First, you know I’m no fan of the Federal Reserve. So, it can be quite difficult to muster up good things about them, but we have to give credit when credit is due. Don’t get me wrong, I’m not all of a sudden a FED fanboy dancing to the music with the passion of a Swiftie, but they may be playing this one pretty well.
Remember, if the FED cuts rates too much and restarts the “inflation” engine, they will have to go into another rate hike mode. On the other hand, if they keep rates too high as the economy is slowing to “normal” speed, it will risk a recession. That’s the Catch-22 the FED finds itself.
(As a side note, I do think the FED will ignite more inflation – just not yet. And I do think the FED will have their hands in a recession in the economy – just maybe not this year.)
So, the BLS cuts the number of jobs created over the last year by 818,000. That’s not really a surprise for those of us paying attention. The unemployment rate is now 4.5%, up from low of 3.6% in April of 2023.
We’ve been speaking for some time about the Leading Economic Indicators (LEI) and how weak they have been. Remember, unemployment is a lagging indicator.
You can see above that the LEI (blue line) has been negative for a while, but GDP has been holding up just fine, which is not something you would expect historically. Is it possible there are still COVID issues being worked out in the economy? For sure!
So today the market is having a day of increased volatility and that is manifesting itself to the downside. But why? Well, the ISM manufacturing survey came out weaker than expectations had anticipated, and construction spending was negative. An ISM print of 47.2 is not great (below 50 signals a recession in that industry). In this case, the index has been below 50 since November 2022 (save March 2024).
So, this print isn’t anything new, it is now just adding to the “belief” that the market is concerned about a recession.
A slowdown in the economy is what the FED wanted and was needed (at least according to FED participants) to get inflation down. I, of course, believe there was a different way to get inflation down that didn’t involve putting people out of work. That would be to increase productivity and make more stuff. More supply (same demand) would push prices down (but what do I know?).
So now the FED is getting what they want (inflation heading back toward 2%), but the market’s concern is if we go into a recession, inflation will then start to undershoot that 2% number. The second mandate the FED has is “full employment.” Well, when I was in B-school, full employment was considered 5%. The last couple of decades, that number has worked its way toward 4%. But right now we are at 4.5% and likely going higher. Does it stop at 5%? 5.5%? Not sure. Does that constitute “full employment”? Full employment tends to be a moving target.
If the FED is behind the curve and needs to cut rates faster, they can easily catch up with the “market’s” expectations. Right now, the markets are pricing in 3-4 interest rate cuts this year (a total of 0.75% - 1%)
There are only three meetings between now and the end of the year. Typically, the FED does not like to appear political, so it refrains from raising or cutting interest rates around elections. Fortunately for them, two meetings are after the election, so they can cut without fear of swaying the election one way or the other. But right now, it looks like 0.25% cut in September, 0.50% in November, and maybe another 0.25% cut in December. Sort of depends on how the data comes in.
This is where it is hard for me to say that I think the FED may actually pull off missing a full-blown recession. Don’t get me wrong, I still think we will have a technical “recession,” but nothing like the magnitude of the past few economic downturns. Maybe I’m wrong and the FED drives that car right into the ditch, but I think they may avoid that. Time will tell.
If we are able to avoid a “full-blown” recession I think the market continues to broaden out, meaning the Mag 7 will likely underperform and other parts of the market will do better. Without the help of the biggest stocks in the market, it will be hard to make meaningful progress at the index level. Passive strategies may underperform, while small/mid cap stocks, value stocks, and even international stocks outperform the tech stocks that have received so much attention over the last couple of years.
I hope you had a great holiday weekend and were able to get out and enjoy it. If you have questions or want more in-depth information about these issues, please reach out and we are all happy to have that conversation. I hope you have a good week. For those of you sending kids off to school this week, may the year ahead be a great one for your young ones!