Stocks Bounce Back
Following the worst week since March 2023 for the S&P 500 in the first week of September, the index soared 4.1% last week and was higher all five days of the week, completing a perfect week. Interestingly, August also had a perfect week, making this the first time since September and October 2019 we saw back-to-back months with a perfect week.
As we’ve noted the past two weeks, the calendar is doing no one any favors during the historically poor September and October period, but last week was a nice change with stocks moving higher to within just a chip shot of a new high. Was there any one specific event driving the bounce? There really wasn’t. But take note that it’s the second part of September that usually tends to see trouble, so some more volatility and choppiness over the coming weeks is still entirely possible. Let’s not forget the S&P 500 has been higher nine of the past 10 months and some occasional consolidation, while scary, can actually be healthy.
On Wednesday stocks initially tanked after inflation data came in a tad hot, with the S&P 500 down 1.6% about 90 minutes into the trading session. Then a funny thing happened—a huge reversal took place, with stocks closing the day up more than 1%. You have to go back to mid-October 2022 and the end to that vicious bear market for the last time we saw a reversal like that.
We found 22 other times since 1970 the S&P 500 was down at least 1.5% intraday but up more than 1% at close. A year later the index was up a median of more than 16%, with the near-term returns above average as well.
One more positive is the action in high-yield corporate bonds. These are companies that have lower credit ratings, so if you loan them money you might not get paid back. As a result, they have to offer higher yields on their debt. The bottom line is if the economy was truly about to fall apart like so many economists keep telling us, we’d expect to see more weakness in high-yield bonds right here. Instead they are making more than two-year highs, yet another sign the economy is on firm footing despite what the nightly news tells you.
A Big Rate Cut May Be Coming but Wouldn’t Be Scary
The Federal Reserve’s next policy meeting will conclude on Wednesday, September 18 and it’s going to be a big one. The Fed will almost certainly begin cutting the fed funds rate, ending the most aggressive rate hiking regime since the early 1980s. No matter what the Fed does, policy will still be in restrictive territory, but the direction matters.
The big question is whether the Fed will do a “normal” 0.25%-point cut or go big and do a 0.50%-point cut. Based on fed fund futures prices, the market currently sees a 59% of the Fed going big and a 41% chance of the Fed going with a normal cut.
We’ve been arguing for a while that the Fed needs to “go big” sooner rather than later by starting their rate cut cycle with a 0.50%-point cut. Labor market risks are rising, and the August payroll data wasn’t all that comforting. At the same time, the latest inflation data showed that the inflation fight is all but over. In short, risks to the Fed’s employment mandate are a lot higher than the risks to their inflation mandate right now. Even if these risks were perceived to be “balanced,” policy rates are well above normal and so the case for normalizing sooner rather later seems clear. Early in the week it looked like the Fed was poised to start cutting rates gradually, with markets penciling in a 0.25%-point cut at their September meeting with close to 85% probability as of Wednesday, September 11.
This was upended on Thursday, September 12. Famed “Fed Whisperer” Nick Timiraos (a reporter at the Wall Street Journal), wrote a piece laying out various arguments for a large cut by former Fed officials and even a former senior advisor to Fed Chair Powell. The signal was clear as mud: there’s no internal consensus at the Fed. It’s likely going to come down to Powell, who was the one Fed official who has not used language like “gradual” or “careful” in describing the expected policy path. Instead, in his speech at Jackson Hole three weeks ago, he said that the Fed wouldn’t tolerate further labor market weakening. Timiraos’s comments in the context of Powell’s Jackson Hole speech has the odds of a 0.50%-point cut drifting towards being a small favorite as of this writing.
Would a Large Cut Signal Recession and Hit Stocks?
There’s been a lot of handwringing over whether a large cut up front is risky and would adversely hit stocks. The argument is that it signals panic, and perhaps signals that the Fed knows something that the rest of us don’t. However, if anything has been clear over the last few years, it’s that the Fed doesn’t have any more information than the rest of us. Instead, a Fed that falls increasingly behind the curve as labor market indicators remain in a downtrend is probably more likely to be more detrimental for stocks.
There’s also a concern that Fed “panic cuts” have historically signaled a recession ahead. But context is important. Below we put together a chart showing what stocks did after historical rate cut cycles began. Except for 1989, the 0.50%-point cuts all coincided with recessions – 1990, 2001, 2007, and 2020 – and stocks were hit over the next 3-6 months. But here’s the thing – in each of these cases, the Fed was well behind the curve and was playing catch-up. The economy was already in a recession, or close to one, by the time they began cutting rates.
- The 1990 recession started in July 1990 (the Fed went 0.50%-points in July)
- The 2001 recession started in March 2001 (the Fed cut in January)
- The 2007 recession started in December 2007 (the Fed cut in September)
- The 2020 recession started in March 2020 (the Fed cut in March amid the Covid panic)
Take the “recession cuts” out, and stocks actually did quite well over the following 3-12 months.
The good news is that we’re not in the middle of a recession now, nor is one imminent over the next three months or so. It’s just that a Fed that falls behind the curve leads to rising recession risks 6-12 months from now. Subjectively, we would say the odds of a recession are about 25% right now, so it’s not at all our base case, but a lot depends on the Fed getting ahead of the labor market data.
Ironically, despite more uncertainty now about how the Fed will start this rate cut cycle, markets have responded well to the possibility of the Fed going big, the S&P 500 rising strongly since Timiraos’s article was released and the Russell 2000 Index of small cap stocks up even more strongly. It’s still early, but all signs are that the market doesn’t seem to be thinking a 0.50%-point cut would be a recessionary panic cut either.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly-traded companies from most sectors in the global economy, the major exception being financial services.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
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