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Market history is full of times of stress in the third quarter of they year, and everyone knows of the market crashes that have occurred in the past. But most of the time, this stress is centred on the equity market and is the result of market excesses. Only time will tell if the current spate of market stress develops into something along the lines of previous events. But what is unique this time is that while equities certainly have built in some risk, the real developments that could cause this weakness are coming from the fixed-income markets.
By the numbers September total return
as at October 1, 2023
S&P/TSX Composite Index -3.3%
Energy (top sector) 1.8%
Information Technology (bottom sector) -9.1%
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S&P 500 Index -4.8%
Energy (top sector) 2.8%
Real estate (bottom sector) -7.2%
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Gold US$1,848.68
-4.72%
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WTI oil US$90.79
8.6%
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US 10-year Treasury yield 4.57%
46.3000bps
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So far, this year has been a whipsaw for investors. We entered the year with everyone looking for a recession. The only debate seemed to be if it was going to be a “hard” or “soft” landing. However, the American economy proved much stronger than everyone had predicted, led by a consumer who was continuing to spend. This was able to push back these fears and contributed to a strong bounce for markets at the beginning of the year. At times, we even began to hear comments around a “no landing” scenario, pushing recession odds away entirely.
By the summer, the strength in the economy was beginning to become worrisome. Was it too much of a good thing? Central banks, which had been expecting to be on pause by the spring, remained hawkish and kept tightening interest rates in a bid to stamp out inflation. Investors became complacent, yet bond yields began to tell a different story as yields, which had been falling, resumed their up move, hitting cycle highs.
At this phase, the market began to get the long-awaited slowdown in economic data. But its delay, which kept rates higher for longer, has pushed the market on the verge of one of the worst economic scenarios – stagflation, which is what has caught up to markets in September.
Higher commodity prices, with WTI crude at $90 per barrel, are making it difficult to see inflation aggressively pulling back anytime soon. This will keep interest rates higher, which is beginning to have its intended intent of slowing the consumer, as housing prices begin to fall. Banks are beginning to report signs of stress in the system, leading to cautious comments. Investors who had grown complacent throughout the summer hit the sell button when they returned from their summer holidays.
Equity markets had their worst month of the year and, in many cases, have given back most of their year-to-date gains. Technology stocks took the brunt of the selling, with the Nasdaq off 5.8%, as the higher interest rates affected multiples but continued to have strong performance on the year. In a rare case of positive news during the month, the technology sector was also able to welcome two long-awaited IPOs in ARM Holdings and Instacart. While both have seen mixed performance post-IPO, the fact that demand was there to launch them was a success and shows investor appetite remains.
There were not many hiding spots during the month, as almost all sectors were negative. Yet real assets, which are acting as a hedge against inflation, were able to provide some relief led by the energy sector. One area that is beginning to show its long-awaited promise is uranium, which has a new lease on life, as it’s being viewed increasingly as a “clean energy.”
The problem we now face is that no part of the market is priced for a “hard landing.” Central banks are now signalling that they are ready to pause. Until that happened, “bad news” in the economic data was viewed as a positive because it increased the odds the banks would move to be on hold. That has now occurred, and markets will need to see economic data begin to improve. The banking and consumer sectors need to see improvement. Once again, “good news” is good.
Markets remain in the seasonally weak period, yet measures of volatility remain near the lows. Sentiment has been getting much more bearish, which in a contrarian world is a good thing. Investors are now fully aware of the risks that have developed as a result of central banks enacting one of the most aggressive tightening cycles in history. A “hard landing” isn’t necessarily the base case, because much of the economy is on sound positioning and holding significant levels of cash. Yet risk remains until that path is determined, and a defensive stance is recommended.
Greg Taylor, CFA, is the Chief Investment Officer of Purpose Investments Inc.
Notes and disclaimer
Content copyright © 2023 by Purpose Investments Inc. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared on the “Macro commentaries” page of the Purpose Investments’ website. Used with permission.
Charts are sourced from Bloomberg unless otherwise noted.
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