September is typically the most volatile month of the year, historically speaking, and that proved to be the case yet again in 2020. Investor concerns over multiple issues weighed on the market last month. The market was looking for reasons to take a step back from the relatively euphoric highs of August and found them in COVID-19, along with election volatility and lingering tensions with China.
The weakness spanned the market with only utilities and materials finishing ahead for the month. Not surprisingly, the energy sector continues to lag under all market conditions, with the sector falling 14.5% in September. With WTI crude closing below $40 a barrel for the first time since June, the ongoing prisoner’s dilemma in the oil patch is likely to persist for some time, continuing to hamper income statements and balance sheets in the sector.
U.S. Large Cap Growth took a breather in September as technology stocks sold off following August’s epic performance. Recall that August was the fourth-best month since the March 2009 bottom in absolute performance for growth stocks, and their second-best month relative to value. Given that context a breather in September was very much in order, affording the stocks a momentary respite in preparation for another leg higher.
The U.S. dollar, which had been struggling, stabilized and even strengthened a bit in September. The move appears as a counter-trend and is likely just that: a modest counter-trend rally amidst a larger downtrend. Precious metals, meanwhile, reacted sharply to the dollar’s relative strength while Emerging Markets managed a fairly solid month despite it, outperforming U.S. equities by a bit more than 200 bps.
International Developed stocks remain weak with limited exceptions, such as Japan and Sweden. Our models continue to suggest that now is a moment to refrain from any investment here; the caution stems from lingering economic weakness coupled with concerns about the possible impact of increased coronavirus numbers on the economy, especially in Europe.
Varied Responses to News of Many Kinds
Fixed income returns were strong as rates around the world dropped on concerns of global economic weakness. This was less the case in the U.S., where rates remained relatively flat based on solid (albeit not spectacular) jobs numbers. The September jobs report indicated the U.S. added 661K jobs, with the boost joined by some upward revisions to prior months, while the unemployment rate lowered to 7.9% from August’s 8.4%. The bond market viewed these numbers with a yawn, as neither bond rates nor the federal fund futures rate moved on the data. So while this was neither a bad report nor a great one, it adds additional support to the view that yields will be stable for a while, likely leading to an increased sense of urgency between Congress and the White House to successfully craft and pass another stimulus package.
Markets tend to take a “shoot first, ask questions later” approach to unexpected events, and this was the case early Friday morning, October 2, when news spread of the president’s positive COVID diagnosis. While initially twitchy, markets soon calmed as investors recalled that not only was this a reasonable possibility, but that therapeutics appear to be on the near horizon. Any deterioration in the president’s condition over the next few weeks is sure to destabilize the markets further, but absent any development on this front, the markets have likely already absorbed their biggest impact from the initial announcement.
Focusing on the Bigger Picture
With news coming fast and furious this fall, what should investors make of it all as they look to the future?
First, attempt to ignore the headlines as much as possible and look instead at the price action in the markets.
Headlines between now and the election are likely to be volatile, as exemplified by Friday’s announcement about President Trump testing positive for COVID-19.
Bear in mind also that the rough patch in historical seasonality has nearly run its course; this annual trend usually ends in mid-October, especially in presidential election years. In fact, the S&P 500’s annualized volatility in the weeks leading up to and out of presidential elections since 1964 was lower than the annualized volatility for the remainder of those calendar years.
Earnings expectations are ticking up and bankruptcy filings are slowing on the fundamental outlook that is much improved from trough levels of activity. While both will take some time to get back to a more acceptable level, the trends are clearly moving in the right direction—much like what we saw coming out of the Global Financial Crisis.
As of this moment, the market is between a tight band of support and resistance.
The default position right now is that equities will continue higher, eventually breaching resistance owing to strength in indicators that tilt bullishly:
- Credit spreads continue stable and are edging lower
- The yield curve is not flattening (notably the spread between the 2-year and 10-year notes)
- Strength persists in commodities, particularly copper
- Continued strength in pro-cyclical areas such as transportation, consumer discretionary and semiconductor stocks
While many indicators are moving in the right direction, there are some concerns. Most notable is the fact that oil prices are struggling yet again, which is significantly impacting inflation expectations. After bottoming in March and subsequently rising back to pre-pandemic levels, inflation expectations for both the U.S. and Europe have quietly begun to roll over again. This bears watching because the Fed has stated it is willing to let inflation run a little hot, should it occur. In terms of equities, a sharp decline in inflation expectations could lead stock prices to break support level; remember, though, that in such a case the break typically rests on fewer individual equities making new lows rather than a market-wide descent.