Investors could face an additional hurdle to the traditional September weakness. stocks posted their worst weekly performance in more than a year, amid one of the most significant moves in the bond market since the Covid pandemic.
U.S. stocks, which peaked in mid-July before falling sharply in early August, attempted to regain their record highs last month but failed to find momentum in either Federal Reserve Chairman Jerome Powell's Jackson Hole speech or Nvidia's presentation. (NVDA) second-quarter fiscal earnings were solid but not spectacular.
The up-and-down pattern of the past two months has raised concerns about a so-called double top in the S&P 500. A double top occurs when the index makes two recent highs with a moderate decline in between before extending a longer-term pullback.
<blockquote class="twitter-tweet”>
The S&P 500? twitter.com/search?q=%24SPY&src=ctag&ref_src=twsrc%5Etfw”>$SPY Double Top Only? image.twitter.com/uexWZCO5Op
— Bar Chart (@Barchart) twitter.com/Barchart/status/1832506535467176244?ref_src=twsrc%5Etfw”>September 7, 2024
Meanwhile, the double-top pattern comes just ahead of the first inversion of the U.S. Treasury yield curve in more than two years, a move that many analysts see as a precursor to recession in the world's largest economy.
Benchmark 2-year Treasury yields fell below their 10-year counterparts last week and have remained lower heading into Monday's trading session, following the longest inversion on record, which began in July 2022.
An inverted yield curve typically signals recession risks, but the recession it predicts does not occur until the yield curve normalizes, and short-term yields fall below long-term yields.
Is a bond market tightening looming?
Treasury yields, which move in the opposite direction to prices, can reflect both bets on near-term Fed interest rates and speculation about the health of the broader economy.
Lower yields on benchmark two-year Treasury notes now suggest interest rate cuts by the Federal Reserve, which are expected to begin on Sept. 18 in Washington and continue into early next year.
However, they are falling faster than long-term yields, which are influenced by investors looking to put money into a risk-free asset as the economy weakens.
This so-called bullish steepening is usually associated with Federal Reserve easing cycles, but it has also evolved before the recession of the early 1990s, early 2000s, and just after the 2008 global financial crisis.
Benchmark 2-year notes were last seen trading at 3.708%, compared with 3.761% for 10-year notes.
Related: Jobs surprise bolsters case for further Fed rate cuts
“Short-term yields fell significantly in all recessions, while long-term yields varied, influenced by the Fed's actions and market expectations about future growth and inflation,” said Althea Spinozzi, head of fixed income strategy at Saxo Bank.
“In all three scenarios, bonds gained while stocks plummeted,” he added, noting that the S&P 500 fell 35.7% during the Great Recession from 2007 to 2009, with most of the decline occurring amid aggressive rate cuts by the Federal Reserve.
The economy is slowing, but there is no recession yet
The economy, while slowing, is still far from a recession. But the weaker-than-expected August jobs report, which included downward revisions for June and July, suggests a difficult road ahead through the end of the year and beyond.
Crude oil prices, which typically reflect global demand linked to economic growth prospects, are trading at their lowest levels in more than a year. WTI futures for October delivery remain firmly below the $70 per barrel mark.
However, Rick Rieder, BlackRock's chief investment officer for global fixed income, does not believe in the recessionary gloom and argues that the US economy is ““moderate” and not “fall off a cliff.”
Related: stock market seeks lost power after a rout
“While the jobs data is clearly weaker than what we and the Fed are used to seeing, it is a far cry from a doom-laden recessionary indicator, a hard landing, or some ominous harbinger of future consumer weakness,” he said.
The bond market's recent track record on recession predictions isn't stellar either, with the world's largest economy defying its gloomy outlook for all of 2022, 2023 and the first half of this year.
Earnings growth remains solid
The Atlanta Federal Reserve GDPNow The forecasting tool suggests a growth rate for the current quarter of 2.1%, below the 3% pace recorded during the three months ended in June but still far from contraction and recession.
S&P 500 earnings estimates are also holding up: Third-quarter profit is expected to rise 5.7% from last year to $513 billion.
For the full year 2024, profits are forecast to rise 10.2%, more than double the 2023 total, before increasing another 15.4% in 2025, according to LSEG data.
Still, the benchmark S&P 500 index has fallen more than 4.2% this month, pushing it into negative territory for the quarter. And with a price-earnings multiple of around 21.2 times, it remains expensive by historical standards, in the face of a likely economic slowdown.
Related: Fed rate cuts may not guarantee a September stock market rally
Investors now look to this week's August inflation reports, next week's Fed rate decision and the start of the third-quarter earnings season in early October to gauge the market outlook heading into the final months of the year.
A higher-than-expected inflation reading could solidify bets that the Fed will take its rate-cutting cycle slowly and raise concerns that the economy is beginning to buckle under the stress of high borrowing costs.
More economic analysis:
- Kamala Harris sees the stars of the markets align against Donald Trump
- CPI report contradicts bets on a sharp Fed rate cut
- Main Street business owners push back against Wall Street's doom and gloom over recession
A subdued start to the third-quarter reporting season, which comes just weeks before the November election, could add another layer of caution to an already nervous market.
“After more than two years of obsession with inflation, markets have turned a corner,” said Chris Larkin, managing director of trading and investments at Morgan Stanley's E-Trade.
“The first week of September followed the seasonally bearish pattern as weak economic data fueled debate over the possibility of a recession and whether the Fed will cut by 0.25% or 0.5% later this month,” he added.
“But for traders and investors, the more immediate concern is volatility. Last week was the biggest week of decline for the S&P 500 since March 2023 and, if history is any guide, the road could continue to be bumpy,” Larkin said.
Related: Veteran fund manager sees world of trouble ahead for stocks
<script async src="https://platform.twitter.com/widgets.js” charset=”utf-8″>
