- Oct. 3, 2023
Third-quarter's pain is often fourth-quarter's gain.
- The recent surge in interest rates has been the dominant driver across financial markets of late. This has been prompted primarily by a recalibration of expectations for upcoming Fed policy, with market sentiment getting sapped by Fed commentary suggesting monetary-policy settings will remain restrictive for longer than investors previously anticipated.
- The 10-year Treasury yield jumped above 4.6% at one point last week, its highest since 2007. After a decade and a half of ultra-low interest rates, this has come with some discomfort. However, we've seen these episodes of surging rates produce attractive catalysts for stock-market rallies over the last year and a half. Previous peaks in the 10-year yield in June and October of last year, as well as March of this year, were followed by healthy gains in equities in the ensuing months.*
- Importantly, the inflation backdrop is notably more favorable this time around. Last year's rising-rate phases occurred as inflation was rising. Today, inflation is in a sustainable (though probably not perfectly smooth) downtrend. Admittedly, longer-term yields have risen higher than we anticipated. But with consumer price pressures moderating and the Fed's tightening campaign near its end, we think there's a case to be made that rates are close to their peak for this cycle. Thus, if inflation continues falling and economic momentum softens in the coming months as we expect, then a drop back in rates could set the stage for a year-end rebound.
Volatility index indicates pessimism, but not panic.
- September was a lousy month, with the S&P 500 falling nearly 5%. Rising rates and concerns that tighter Fed policy will undercut the economy drove additional weakness in growth and small-cap investments, with the Nasdaq and Russell 2000 indexes both shedding close to 6% for the month**. This capped off an overall 3% drop for the S&P 500 for the third quarter, the first quarterly loss in a year.
Source: *Bloomberg, price performance of the S&P 500 index.
- After hitting a post-pandemic high in July, the stock market has pulled back by nearly 7% through August and September. This is the third such dip in the last year, with stocks falling 7.8% in February-March and 7.3% last December. However, after the Feb-March dip, the market rallied by 7.5% in the subsequent one month, and then rallied by 7.6% in the month after the December dip, highlighting the opportunities that can come from short-term pullbacks.