After a great start to the quarter in July and August, September was when the storms hit. Here in the U.S., markets pulled back significantly. The Dow declined by 4.2 percent for the month and 1.46 percent for the quarter. The S&P went down by even more for the month, at a 4.65 percent decline, although it gained 0.58 percent for the quarter. Finally, the Nasdaq trailed by even more, at a 5.27 percent monthly drop and a 0.23 percent loss for the quarter. Abroad, international markets were also hit, with developed markets down for both the month and quarter, at 2.9 percent and 0.45 percent, respectively. Emerging markets dropped 3.94 percent for the month and 7.97 percent for the quarter.
Let’s take a look back at what drove these declines, as well as what we might expect ahead.
A perfect storm of market concerns. What drove the September declines was a reversal of much of both the medical and economic improvements seen in July and August. On the medical front, the Delta wave brought medical risks back to the forefront, generating a slowdown in hiring and consumer spending that has raised economic risks. On top of that, at month-end, the Fed indicated that it would start tightening policy, leading to a rise in interest rates. In many respects, it was a perfect storm of market concerns all in one month, and it generated a sharp reaction.
Covid back on the front page. On the medical side, the Delta wave of the virus really started to hit in midquarter and rose sharply through mid-September, raising the possibility that rising medical risks would hurt economic growth and potentially even lead to shutdowns again. Supporting that possibility was the increase in the positive testing rate and a sharp increase in hospitalizations and deaths. Covid moved back to the front page in both the headlines and the statistics in September after being largely absent in July and August.
Economic stats take a hit. It also moved back into the economic statistics. We saw a sharp decline in hiring, from more than 1 million in July to less than a quarter-million in August. Layoffs started to rise again during the month, after declining earlier in the quarter, and ended the month where they started. Even as the job market weakened, the expiration around supportive federal programs, including supplemental unemployment insurance and eviction and foreclosure moratoria, raised worker worries and drove consumer confidence down. The drops were significant in both major surveys, and the Michigan survey dropped to the lowest level since 2011. This was a significant change during the month. Weaker confidence is already showing up in weaker spending, and this could well slow things going forward. The market reaction makes sense given these rising risks.
Improving medical news. Even as September ended the third quarter with a substantial increase in risk, however, there are reasons to believe the fourth quarter will be better. The medical news, which drove much of the economic damage, is starting to improve. New case growth, on a seven-day-average basis, was down by one-third during the month of September. The positive test rate was down by a similar amount, and hospitalizations were down by almost as much. The improvement has been sharp, and it may well continue.
Economic risks starting to recede. The economic damage also stopped getting worse as the medical news improved. Layoffs rose but stayed at July levels, and consumer confidence appears to have stabilized. Strong business confidence and investment should provide a tailwind, and even the consumer economy still has substantial momentum. Many of the most significant risk factors, such as the expiration of federal programs, are starting to recede. As we move further into the fourth quarter, we will likely see more improvement as consumers respond to better medical news by going out and spending more.
Markets evaluate the risks. And that is what markets are expecting, although September’s pullback suggests doubts are increasing. Those doubts, however, are based on looking back at the past month or so and could easily be assuaged by stronger medical and economic performance. The market’s economic foundations are still reasonably solid—what appears to have been shaken is confidence, which will improve with the data.
Solid fundamentals. Supporting the idea that the fourth quarter will be better are the fundamentals. Earnings are expected to continue to come in strong. With margins up and sales holding, corporate earnings are expected to rise by 30 percent or more in the third and fourth quarters. Companies continue to sell more and to keep more of the sales as profits. From a business perspective, confidence remains high, and the results are justifying it. A recovery in the medical news and consumer confidence should help keep those positive trends on track.
More positive factors. Another potential positive factor is that even as the market is shaken by both an economic slowdown and the prospect of higher interest rates, those risks offset each other. If the economy does remain weak, that will likely keep interest rates low, which will support the market. Here, too, while there are real concerns, there are also significant positives.
Outlook Remains Positive
While October and the fourth quarter will face challenges, the outlook remains positive. The actual outcome remains unusually uncertain, and the risks we saw in September are real. But there are also signs those risks may be fading—and that the very real positive trends from July and August will reassert themselves. September was the month when the markets started to take the risks seriously. October will be the month when we find out if that continues or if the improving trends turn it back around.
This article is from Commonwealth and written by Brad McMillan, CFA, CAIA, MAI
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