By Michael Mullaney | Director of Global Markets Research
Published September 2023
The stock market’s 5-month winning streak came to an end in August as the S&P 500® Index dropped by -1.59%.
Stock returns were hampered by a combination of rising spot and forward interest rates, the result of the continued resilience of the U.S. economy which was taken as “good news is bad news” that prompted investors to second guess when and to what extent the Federal Reserve would trim rates in 2024. The negative tone to the market was reinforced by Fed Chair Jerome Powell in a hawkish speech delivered at the Fed’s Jackson Hole summit on August 25th.
Market breadth narrowed dramatically during the month as the percentage of stocks in the S&P 500® Index trading above their 200-day moving average fell to 55% from 74% at the start of the month, and only 42% of the stocks in the S&P 500® beat the overall Index return, down from 47% in July.
Year to date, the S&P 500® Index has advanced by +18.72% on a total return basis.
Only One Sector in the Green
Energy was the only sector that produced a positive rate of return in August at +1.81% on higher oil and gasoline prices as energy demands from sweltering temperatures and summer travel strained reduced global resource supply.
The bond surrogate Utilities sector was the most significant laggard for the month, dropping by -6.16% as interest rates rose by an average of 10-basis points for maturities ranging from 2-years to 30-years in length, leading to a fourth straight monthly loss for the Bloomberg U.S. Aggregate Bond Index.
Year to date, the Communication Services, Information Technology, and Consumer Discretionary sectors continued to lead the pack with returns of +45.16%, +44.67%, and +34.65%, respectively. These sectors continued to be led by the so-called “Magnificent Seven” stocks (Apple, Microsoft, NVIDIA, Google, Facebook, Amazon, Tesla) which produced an average return of +93.68%, a cap-weighted return of +73.71%, and contributed 71% of the total S&P 500® Index return through August.
Three sectors have posted losses on a year-to-date basis: Consumer Staples at -0.24%, Health Care at -1.17%, and Utilities at -9.31% on concerns over margin pressures, drug pricing, and rising interest rates, respectively.
“Risk Off” Dominates Trading
“Risk-off” generally set the trading tone during the month as low-quality stocks (those rated “B” or lower by Standard & Poor’s) fell by -6.24% while stocks rated “B+” and higher dropped by -3.84%, and small-cap stocks (Russell 2000® Index) lagged large-cap stocks (Russell 1000® Index), -5.00% to -1.75%. Within the S&P 500® Index, only beta failed to confirm the “risk-off” environment as the highest beta quintile returned -1.67% while the lowest beat quintile fell by -1.78%, though that is largely due to a stock like NVIDIA which has a beta of 1.66 (66% more volatile than the S&P 500® Index) but returned +5.62% during August.
Year to date, “risk on” has generally prevailed as low-quality has beaten high-quality by +9.30% and the highest beta quintile of the S&P 500® Index has outpaced the lowest beta quintile by a remarkable +47.15%. Only small-capitalization stocks have lagged through August, with the Russell 2000® Index gaining +8.96% to the +18.58% return generated by the large-cap Russell 1000® Index.
Value Trails Growth
In terms of style, value lagged across all capitalization ranges in August as the Russell 1000® Value Index, the Russell Midcap® Value Index, and the Russell 2000® Value Index trailed their corresponding Russell growth counterparts by an average of -0.54%. Year to date, growth continues to lead value by an average of +14.53% across the three capitalization ranges, with the biggest disparity still found in the large-cap space where the Russell 1000® Growth Index has outpaced the Russell 1000® Value Index by +26.29%, though backing out the contribution from the “Magnificent Seven”, the outperformance of the Russell 1000® Growth Index shrinks to +3.63%. The Russell 1000® Growth Index is now the most concentrated it has ever been. The top ten names represent over 51% of the Index, whereas back at the peak of the Tech Bubble, the top ten weighed in at 36.5% of the large-cap growth benchmark.
International Stocks Struggle
Returns for developed market international stocks lagged the S&P 500® Index in August, both in local currency terms and more so in U.S. dollar terms. For the month, the MSCI EAFE Index fell by -1.82% In local currencies and by -3.82% in dollars, as the DXY Index, a measure of the dollar’s appreciation (foreign currency depreciation) versus a basket of six foreign currencies (the Euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona) rose by +1.73%. Much of the weakness in the EAFE Index can be traced to the Eurozone, which dropped by -4.61% during August as stagflation fears for the region continue to mount.
The ”risk-off” trading environment during the month also affected the returns of emerging market stocks as the MSCI EM Index fell by -4.65% in local currency terms and by -6.13% in $USD as the MSCI EM Currency Index dropped by -1.51% versus the dollar.
Year to date, both developed and emerging market stocks continue underperform the S&P 500® Index, both in local currency and U.S. dollar terms with the MSCI EAFE Index returning +12.36% (local) and +11.35% ($USD) and the MSCI EM Index up by +6.26% (local) and +4.66% ($USD). The MSCI Emerging Markets Index has been negatively affected by China, which dropped by -8.1% during the month on growing concerns over the country’s Real Estate sector, where both losses and credit delinquencies are rising.
Stocks “Zig” as Yields “Zag”
Evidence of “good news is bad news” can be found by observing the correlation between stock prices and the yield changes of the 10-year Treasury. With economic releases routinely beating consensus estimates, interest rates have been rising which is pressuring stock prices. The correlation between the level of the S&P 500® Index and the yield of the 10-Year Treasury now stands at -.81, where 1.0 equals perfect positive correlation and -1.0 equals perfect negative correlation. The -.81 is an indication that economic growth is too strong. This has also affected the futures market, where earlier in the year Fed Funds futures had been indicating rate cuts upwards of 110 basis points in the first half of 2024 by the Federal Reserve, but now are pricing only 35 basis points of Fed rate cuts in H1 2024.
Powell Remains Hawkish
The decline in expected rate cuts was also augmented by comments made by Jerome Powell at the Jackson Hole Summit where he stated, “Good morning. At last year’s Jackson Hole symposium, I delivered a brief, direct message. My remarks this year will be a bit longer, but the message is the same: It is the Fed’s job to bring inflation down to our 2 percent goal, and we will do so. We have tightened policy significantly over the past year. Although inflation has moved down from its peak—a welcome development—it remains too high. We are prepared to raise rates further if appropriate and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.,” i.e., higher for longer.
Inflation and Employment are Key Macro Drivers
Inflation and employment remain the key macro-drivers for markets going forward. The Core Personal Expenditure Price Index (Core PCE) increased by 0.1% to 4.2% in its most recent release due to a combination of low base effects and high wage growth and remains well above the Fed’s 2% target. Employment, or should we say unemployment, at 3.5% as of this writing remains too low to have a meaningful impact on reducing wage pressure. Wages comprise about two-thirds of the Core PCE and are growing well north of 4% when they need to be 3.5% or lower to be more consistent with inflation running between 2.0% to 2.5%.
The Fed Meets Again
With members of the Fed’s FOMC meeting this month, it will be interesting to see if their update to the “dot plot”, the Summary of Economic Projections and statements reflect an ongoing concern that more hikes are needed to reach their inflation target, though futures are pricing less than a 10% chance of any action at this meeting.
Seasonal Pattern Negative, Momentum Positive
From a seasonality perspective, since WWII, September has been the worst month of the year for stocks, posting a positive return only 45% of the time and averaging a loss of -0.73% for the month.
On a more positive note, since WWII, the S&P 500® Index has been up 17% (price) or more through August twelve times. In ten out of those twelve occurrences (83%), the S&P 500® Index has gone on to gain an average of +4.17% through the end of the year.
Terms and Definitions:
Beta: A measure of a portfolio’s market-related risk or its price movement in relation to a benchmark. Securities with betas higher than 1.0 have been, and are expected to be, more volatile than the benchmark; securities with betas lower than 1.0 have been, and are expected to be less volatile than the benchmark.
S&P 500 Index: The S&P 500 Index is a registered trademark of the McGraw-Hill Companies, Inc. and is an unmanaged Index of the common stocks of 500 widely held U.S. companies.
MSCI EM (Emerging Markets) Index: Captures large and mid-cap representation across emerging markets countries covering approximately 85% of the free float-adjusted market capitalization in each country.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index.
Russell 1000® Growth Index: Measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with relatively higher price-to-book ratios, higher I/B/E/S forecast medium term (2 year) growth and higher sales per share historical growth (5 years).
Russell 1000® Value Index: The Russell 1000® Value Index contains stocks included in the Russell 1000® Index displaying low price-to-book ratios and low forecasted growth values.
Russell 2000® Value Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index. The Russell 2000® Value Index contains stocks included in the Russell 2000® Index displaying low price-to-book ratios and low forecasted growth values.
MSCI EAFE (Europe, Australasia, Far East) Index: A free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. & Canada.
MSCI EM (Emerging Markets) Index: Captures large and mid-cap representation across emerging markets countries covering approximately 85% of the free float-adjusted market capitalization in each country.
Bond credit ratings are measured on a scale that generally ranges from AAA (highest) to D (lowest).
Core PCE – The Personal Consumption Expenditures Price Index is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behaviour. For example, if car prices rise, car sales may decline while bicycle sales increase.
Boston Partners Global Investors, Inc. (“Boston Partners”) is an investment adviser registered with the SEC under the Investment Advisers Act of 1940. The views expressed in this commentary reflect those of the author as of the date of this commentary. Any such views are subject to change at any time based on market and other conditions and Boston Partners disclaims any responsibility to update such views. Past performance is not an indication of future results. Discussions of securities, market returns, and trends are not intended to be a forecast of future events or returns.
FOMC: Federal Open Market Committee
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