Key Points:
- September has historically been a challenging month for stocks, and this year was no exception with most indices declining.
- The Federal Reserve raised the Fed Funds rate by 25 basis points as inflation remains above target
- Yields in the bond market have moved higher on strong economic growth, higher inflation expectations and worries about debt levels.
The “September Effect”, where stocks have historically tended to struggle during the month, lived up to its reputation as equities across the globe came under pressure. While market pundits can give various reasons for the phenomenon (quarterly rebalancing, tax loss harvesting, portfolio window dressing etc.) this year the culprit was sticky inflation and higher interest rates. Elevated energy prices and ongoing geopolitical conflicts are pressuring yields across the globe to rise. The Federal Reserve raised their benchmark interest rate (Fed Funds Rate) by 25 basis points in a widely anticipated move. Higher rates are targeting persistently stubborn inflation, and further increases could slow down the economy and overall risk-taking. While the Fed can influence short-term rates, longer-term rates in the bond market have moved materially higher this year from stronger economic growth, stickier inflation, the AI buildout (hyperscaler borrowing) and worries about the US debt and fiscal sustainability.
The Dow Jones Industrial Average fell 4.1% during the month while the S&P500 slipped 0.4%. The NASDAQ gained 1.9% as technology +4.5% and communication services +4.3% were the only positive sectors of the US market. Financials were hit the hardest on higher rates, falling 7.2%, while materials (-6.7%) and real estate (-6.1%) rounded out the bottom performers with their high debt levels. Small cap stocks sold off over 5% during the month as many smaller US companies rely on revolving, floating rate debt to fund operations. Higher rates hit their bottom lines and reduce present values of future cash flow. Small caps are still outperforming their larger counterparts for the year while value stocks are outperforming growth.
Outside of the US, the MSCI EAFE Index fell 3.1% while emerging markets dipped 0.6%. Bond yields across the globe have gone up as the supply shock to energy markets weighs on economies. The US bond market has struggled this year with interest rates moving higher across the curve. The yield on the 10-year Treasury bond finished September at 5.3% after starting the year at 4.2%. Higher yields push down prices of existing bonds and vice versa. While rates may continue to move higher, current yields in the bond market are the most attractive we have seen since the early 2000s. The US economy is proving to be quite resistant to higher inflation, but higher energy prices may start to curb consumer spending. If the energy supply disruptions get resolved and prices start to normalize, inflation expectations and corresponding yields may begin to ease.
Sources: Morningstar Direct, Wall Street Journal, Merrill Lynch