There is some positive history on our side when it comes to both August and September posting back-to-back negative monthly returns. 2023 represents the 18th time since 1950 that the S&P 500 posted back-to-back negative returns and surprisingly, the forward market returns tend to be very positive.
In years where the performance S&P 500 in both August and September are negative, we can breakdown the expectations for the 4th quarter into two separate categories: years where the S&P was positive through the end of September, and years where the S&P was negative through the end of September. For years where the S&P has been positive through the end of September the average has occurred:
The average return for the S&P in the 4th quarter was 9.20%.
The average monthly return during the 4th quarter was 3.0%.
The average return over the last 5th months of the year (including Aug & Sept) was +5.3%.
On the other hand, when the S&P was negative through the end of September, there was not much difference in the bullish action of the 4th quarter.
The average return for the S&P in the 4th quarter was 5.20%
The average monthly return for the S&P during the 4th quarter was 1.8%.
While markets that are negative through September tend to end down for the year, there has been one year (1956) where the market ended the year positive, and two other years (2011 & 2015) where the market finished the year about flat.
Although there is no guarantee, history suggests that the market will rally into the end of 2023.
“Rate of Change”
Once again, August and September both have made a strong claim to retain their “worst trading months of the year.” After losing about -1.8% in August, the S&P shed another -4.90% in September as fear of exploding yields in the Treasury markets continued to spook investors. While we continue to point fingers at the Fed and their inability to communicate their message clearly to investors, there is another influence on Treasury yields for the first time in several years.
Back on June 3rd, after tense negotiations, Congress passed, and President Biden signed into law, a deal that would suspend the debt ceiling until January 2025. Many argue that the debt ceiling is outdated and no longer necessary, but in August and September we saw the amount of debt issued by the US Treasury increase by more than 10%. While this might seem like a lot, keep in mind that the Treasury is issuing more than $200 billion worth of debt every month. Over the last two months, we have seen an additional $24 billion in debt issuance, which equates to more than $1.6 billion in annual interest payments.
The country has a spending problem. Through September, the federal budget deficit was $1.4 trillion, which is up more than $600 billion from 2022. The current 2023 deficit represents roughly 7% of our annual GDP, an amount that is almost twice as large as last year. Expectations are that the 2023 budget deficit will end the year closer to around $2 trillion, higher by more than $1 trillion from 2022. Unless there are meaningful spending curbs that are put in place, the Treasury must issue more debt, which creates a vicious cycle. Issuing more debt will inversely affect demand, and lower demand will cause the interest yield on the new debt to increase.
While the market can handle higher Treasury yields, it’s the speed that these yields rise (or their rate of change) that can cause the market to become dislocated, as it has over the last two months. The month of September saw one of the largest months over month rate changes in the 10-year Treasury yield over the last 53 years at +11.73%. This rapid increase was caused by comments from the Fed, but also greatly influenced the amount of additional debt issued by the Treasury. Thankfully, these bouts of volatility in bond yields tend to be short lived, which allows the equity markets to readjust themselves and move forward.
Our opinion is that the Fed is finished raising rates for this cycle, while they continue to stress a higher for longer stance, removing the expectation of future rate hikes will greatly reduce the amount of volatility in yield moving forward, which again is market positive. But the increase in deficit spending and the need to issue higher amounts of debt by the Treasury will make yields much more ‘sticky’ moving forward than what we have seen over the last decade and a half.
The Federal Reserve Reform Act of 1977 expand the role of the Fed to promote maximum employment and price stability within the US economy. This is referred to as the Fed’s ‘Dual Mandate”, which factors in certain inflation levels as well as the monthly unemployment rate. Since the Fed started to hike rates last year, they have been focused on getting inflation back to the 2.0% level with the understanding that unemployment would have to increase to get there. Again, this is part of their desire to destroy demand within the economy to lower inflation, instead of working to increase production to even out the supply/demand imbalance.
Although inflation has moderated over the last year, so far unemployment seems unaffected by the aggressive policy action of the Fed. The unemployment rate since the start of 2022 has remained under 4%, including the Sept non-farm payroll data which showed unemployment remained flat at 3.80%. In the financial world, the lack of an increase in the unemployment rate over the last 21 months is really a headscratcher. This was made even more confusing by the 336,000 new jobs added to the economy in the month of September, well above Wall Street expectations, and the ADP September number of 89,000 new jobs created. Thankfully, the Bureau of Labor Statistics releases all their data, which allows us to see that the labor market is finally starting to show some cracks.
With the headline number of 336,000 new jobs added in September released last Friday, the market futures quickly flipped negative since such a strong report would give the Fed more room to raise rates going froward. But as quickly as the market flipped negative, it turned around and rallied throughout the rest of the day, posting one of the best days of the year. While the headline number was strong, once investors were able to read the whole report, they realized that the overall employment data was much weaker, leading to the belief that the Fed would not have to remain as aggressive. Here is a breakdown of the data from Friday:
New Jobs Created: 336,000
Full Time Jobs Created: -22,000
Part Time Jobs Created: 151,000
Self-Employed Unincorporated Jobs Created: 222,000
Number of People Holding Two Jobs: 123,000
New Full Time Government Jobs Created: 70,000
Important Points from this Data:
When you remove the 70K new full-time govt jobs created the number of full-time jobs lost in the private sector during the month of September was -92K.
This is the third consecutive month there has been a loss of full jobs in the private sector, the total number of full-time jobs lost since the end of June is almost -700K.
On the other hand, part time jobs increased by 151K in September, and now have increased by more than 1.2 million since the end of June.
The BLS counted 222K self-employed unincorporate jobs for the month, these are considered “gig” workers. Gig workers are independent contractors or freelancers who typically do short term work for multiple clients on an hourly or part time basis. These types of jobs include being a driver for Uber, pet sitter, personal shopper, and cleaner. While many of these jobs are important to our economy, they are not considered high-quality long-term employment.
The final data point is that we continue to see a rise in the number of people holding two or more jobs each month. Over the last four months, we have seen the number of people holding at least two jobs increase by more than 5%.
The devil is in the details, and over the last few months while the top line unemployment data has appeared to be gaining strength, the details of these reports are painting a different picture. The continued weakness in full time non-government jobs, and the massive increase in both part-time jobs and individuals working two or more jobs, is beginning to show the effects of the Fed’s aggressive policy and raises concerns of a potential recession later in 2024.
Looking again at the seasonal chart of the S&P 500 during Pre-Election years, we should expect a significant market low this week, and then a bullish run for the rest of the quarter. It should be noted that 4th quarter performance in Pre-Election years has been strong following a bear market (as we had in 2022) and with a first term president in office.
Helping fuel our expectations that the market is going to see a strong 4th quarter and run higher into the end of the year is the positioning traders within specific futures markets. For example, the bullish stance by traders in the 30-Day Fed Futures contract shows that the market should trend higher at least through the end of January. The bullish stance on the SOFR (secure overnight financing rate) futures show a market that has some bumps along the way but should remain strong for most of the next year. Granted the market can disregard these indicators, history shows that most of the time they provide a great indication of where the market should be headed.
The damage in the market since the end of July has, for the most part, been caused by the rate of change in Treasury yields, and most underlying fundamentals have remained relatively strong. The largest benefit to the market moving forward should come from the ability of companies to beat year-over-year earnings expectations. The last two quarters of earnings in 2022 are an extremely low hurdle for 2023 earnings exceed. This should provide ample fuel for the market to move higher.
There will always be uncertainty that the market has to battle, but when the unknown becomes known, the market is usually well on its way. We truly feel that the Fed is done raising rates for this cycle, the overall weakness in the September jobs report helps confirm our expectations. The other unknown is the continued parabolic move we have seen in yields. While they can continue to move higher, it’s almost impossible to maintain their current rate of change. So as the rate of change in Treasury yields begins to slow and settle back, we expect the market to regain what was lost in August and September, and close out the year much closer to new highs than most currently expect.