“The gray-eyed morn smiles on the frowning night, Checkering the eastern clouds with streaks of light.” – William Shakespeare
“Rate Surge Sends Stocks Tumbling. Worst Day Since March” read one headline on September 29th. The Wall Street Journal , seeking to contribute towards investors understanding of the stock market’s sour mood, offered by way of explanation “…concerns that higher inflation…will stick around longer than expected…as well as data that has shown that U.S. economic growth is starting to slow.” And so ended the market’s seven consecutive months of gains, if not in tears then at least a sniffle or two as September’s 4.7% decline in the S&P also consumed most of the prior three months gains, leaving that index up barely half a per-cent for the not so sunny quarter.
In a world with many problems searching for hard to find explanations, the reason for this market decline is a relatively straightforward one. If one lays a chart detailing the past eighteen months’ growth of corporate earnings on top of a chart of the rise of the S&P 500, it is clear that one explains the other. The market is not inexpensive based upon current valuations so anything that calls into question the ability of those earnings to continue to rise at their expected rates will soon lead to unpleasant conditions for investors. So fellow travelers…peering over the near term horizon should we expect fair weather or foul?
One of the least recognized but most valuable means of understanding the source of the ebbs and flows of financial markets is to recognize that most often it is not whether the news is good or bad that matters, but whether that news was better or worse than EXPECTED. As we enter into October the length of the litany of woes the market is currently digesting is a long one. Debt ceilings, Federal Reserve “tapering”, inflation, economic growth rates, supply chain disruptions, China and the pandemic. The current consensus is that these are all likely to trend in a negative direction. The reality though may well be that the near term future will contain an unexpected amount of sunshine. The pandemic, or at least its economic consequences, is now almost entirely behind us. The closing down of much of the global economy, and its subsequent reopening, has been extraordinarily disruptive but markets will have ironed most of those wrinkles smooth by next Spring. Inflation is indeed transitory with its peak now past and now likely trending lower. The economy will not boom but it will exceed expectations. Evergrande’s looming bond default does not signal a reprise of the Global Financial Crisis. And no, the Federal Reserve will not short circuit our economic recovery by a near term lifting of interest rates, and the better news on inflation will remove that element of pressure that it do so.
With many of the different sectors of the stock market having taken divergent paths only to end with similar year to date returns, still there are some outliers and they are interesting. The poor orphan Energy stocks were up 8.84% for the month and yet are -1.8% for the quarter versus the S&P’s +.6%. The Growth stocks of the S&P’s returned -5.8% for the month but +1.8% for the quarter while the Value stocks were -3.3% for the month but -.9% for the quarter. Technology stocks were -6.4% for the month but are outperforming the S&P year to date 19.3% to 15.9%. Financial stocks, whose weighting in Value stocks is similar to Technology’s in growth, have been the market’s most consistent sector year to date as their -2.2%, 2.3% and 24.9% returns for the month, quarter and year have allowed them to outperform Technology for each of those periods.
Mark H. Tekamp, October 2, 2021