As we turn the corner on another great summer, we are now in the thick of the dreaded September market. This September is packed full of meaty reasons for the world stock and bond markets to have plenty of problems. To get more focused on just the US markets, it is fairly clear that the issues center around:
- The Iran War
- Price of oil and the inflationary impact
- Interest rates eclipsing 20-year highs
- Inflation worries due to last week’s PPI and CPI reports
- Midterm election jitters for the November voting period
- AI policing of rough AI agents
- The September 15th Fed meeting which seems almost sure to see an interest rate hike
All of these are of importance, but the implications of each are a bit different. The war with Iran and the resulting effects on oil prices is very negative for the world. It creates inflation and this is manifesting in higher interest rates abroad and possibly higher rates here after the Fed meeting on this Wednesday.
Interest rates in general are on the rise. This is a good thing when they move up at a gradual pace, but a negative thing for our real estate market which is in dire straits at the moment. The good thing is that it is reflecting continued increases in the general economy and the expectation for these good earning reports to continue for at least a few more quarterly reports. This is another reason why the PPI and CPI numbers are stronger yet not outside the spectrum of strong business expectations.
The midterm elections is sure to be a continued point of contention as it could put us in a “Lame Duck” presidential situation where gridlock ensues as a result of infighting between the parties. Strange as it may seem, the equity markets tend to due better under this situation than a single party situation where the incumbent party is able to push through issues without much the other side of the aisle being able to stop them.
The most recent issue is not only the building out of data centers but also the control of the AI agents. This has created an environment where the leaders of the largest AI platforms are voicing concerns about how to police these bad actors. This is a fairly common issue whenever a new technology that has the potential to change the course of business growth trajectory, but to remember the last ones is difficult as memories are short. I am not dismissing the importance of the current issue but also want to be clear that we are creative and industrious and addressing these kinds of issues were sure to have been expected. Another point that needs to be remembered is that the rate of growth and acceleration of AI really can’t be controlled and should not be should we wish to remain relevant and dominant on the world stage.
The September 15th meeting is looking more likely to include an interest rate hike. This is happening at a particularly strange time as we are in the middle of a military conflict and an interest rate easing cycle. So even though economic indicators are leaning towards a hike, the timing of this one is quite abnormal.
Since mid-May, the markets have produced an extraordinary number of false moves and traps in both directions. Just when it looks as if the all-clear has been sounded and bullish opinions proliferate, the market has tended to drop. Conversely, we have now witnessed countless scenarios where the market appeared headed for a cliff, only for buyers to step in and produce a last-minute save. It is still definitely a bull market, yet it has frequently made fools of anyone who trusted the most obvious moves.
The last two weeks offered textbook examples. The S&P 500 initially held the 7600 region just barely, bounced sharply to the cusp of an upside breakout, and then fell back down to take out 7600 after all. Every step of that sequence appeared as if the market was tipping its hand, only for those tells to be proven wrong within days. Rather than producing an acceleration lower after Thursday’s breakdown, however, the market again responded Friday with a positive, though still insufficient, session. That one-day rally released some of the bearish pressure, but it did not fix anything structurally.
Sentiment has swung just as wildly in recent weeks. CNN’s Fear and Greed Index was firmly in “Greed” territory a month ago but has since fallen to “Fear.” As evidence that equities are working off a bullish overbought condition, it is notable that over 70% of Russell 3000 stocks are trading below their 20-day average (near-term oversold) while over 50% remain above their 200-day average (in a long-term uptrend). Historically, this combination has produced favorable forward returns, supporting our constructive intermediate-term outlook.
This is the tug-o-war that I have been referring to for the last couple of months. Markets will sell off to a point where the majority of companies are trading at very oversold levels (under their individual 20-day moving averages) and then they have collectively advanced back to more normal levels. Historically, and statistically, when this level of pullback occurs yet they collectively are above their respective 200-day moving averages, it is more so considered a sort of pause to refresh.
As I have made clear in recent weeks, the market has been undergoing a correction underneath its surface. This particular case is not one of those where alleged softness can be easily waved away due to extenuating circumstances. Basically, every breadth indicator I track has reflected the pullback across the market. The stealth correction beneath the surface is real, even if it has not yet done tremendous damage to the major averages.
If there is good news to the obvious weakness, it is two-fold:
- It looks as if capital continues to rotate across the market rather than leave it entirely and money that is still seeking a home in stocks is very different from money heading for the exits or to other asset classes. I call this a sector whack-o-mole environment.
- The stealth correction that I referenced above has already carried many indicators close to levels where bottoms have regularly formed over the past few years.
As I alluded to last week, this hopefully means some of the more extreme downside cases I have been tracking are now less likely. We are going to need to see clear downside acceleration just to take the S&P 500 toward the summer lows of 7200- 7300, let alone the 7000 region that has seemed a probable retest target ever since the index broke above there back in April. Also mentioned last week is my growing belief that we might be stuck in this general range for the foreseeable future.
While anything can happen, it seems increasingly likely that some new major development will be required to break the market out of this zone – give or take 5-10% from current levels. So even if we continue to drop in the near term, it might not get very far before we are back to bouncing. And should the bulls take charge more immediately and break the indices out of their recent ranges, it will likely be difficult for the S&P to climb much above 7900-8000 given how extended it is in the bigger picture and how high the expectations bar currently sits.
I might be wrong and all bets are off if, say, oil goes to $200 or the 10-Year yield quickly spikes to 6-7%; but absent that, or something else no one is talking about right now, rangebound may be the prevailing condition for the next few months. That might be just as stock prices are not crashing. I would actually love to see a top in rates and a bottom in bonds coinciding with the Fed hiking this week. That would be a classic “sell the rumor, buy the news” situation, and it would make sense if the market begins to believe the hike will not be immediately followed by more in the months to come. Even though inflation remains a problem, it will increasingly weigh on both consumers and businesses, potentially slowing growth expectations and pulling longer-term rates back down some (providing the lift to bonds).
In closing, the pressure in stocks remains to the downside until proven otherwise. If the S&P can rebound enough to take out its early September high, that could kick off more aggressive buying and short covering to produce a move up toward 7900-8000 next. Absent that, the line of least resistance is lower, and we will need to watch for some alternative bottoming setup to develop.
As with bonds, it would be counterintuitive to get a low in stocks right around the seemingly negative Fed hike. Yet, that is exactly the kind of action we have seen in this “fool me” market, where reversals tend to arrive just as everyone expects a trend to continue. I will stress, however, that we must have clear evidence of such a low rather than blindly anticipating it. The risks are heightened for now and will remain so until we see more signs of improvement.
So, I do think we must approach this important Fed week with extra caution, particularly given the news that Saudi Arabia was forced to close a key pipeline following drone attacks. That is not likely to help the global oil situation, and it makes me even less enthused about getting bold right in front of the Fed. As Scott Bessent was quoted in the Wall Street Journal on Monday, “We’ll get to the other side of this Iran conflict, and the underlying economy is very, very strong., and I think reaccelerating.”
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