Market insights and analysis

By Jason Teed

Market snapshot 

• The major U.S. stock market indexes fell significantly last week. Four factors contributed: seasonality (September tends to be tough for the market), strikes, a potential government shutdown, and the Federal Reserve’s recent hawkish remarks. 

• Treasury yields increased, with longer-term maturities experiencing the most significant gains. The yield curve remains heavily inverted. 

• Gold rose just 7 basis points last week. Conflicting forces were at play: Interest rates rose, making gold less attractive. However, stocks also fell, which was in line with traditional safe-haven-seeking investor behavior. 

• Market regime indicators show the market is in a Normal economic environment stage, which is historically positive for stocks, bonds, and gold but with a substantial risk of a downturn for gold. Normal is one of the best stages for stocks, with limited downside. Volatility is High and Rising, which favors equity over gold and then bonds.

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The major U.S. stock market indexes fell significantly last week, keeping in line with the seasonal trend for September. The Russell 2000 fell by 3.82%, the NASDAQ Composite lost 3.62%, the S&P 500 declined by 2.93%, and the Dow Jones Industrial Average was down by 1.89%.

Last week’s losses were fairly broad, though defensive stocks lost the least for the week. Health Care and Utilities were the best-performing sectors, losing 1.18% and 1.73%, respectively. Consumer Discretionary performed the worst, falling 6.35% as risk-on sectors dropped. This sector behavior indicates investors are expecting an economic slowdown.

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Stocks

Last week’s equity losses seem to have been driven by four different factors, all of which could be a drag on the economy: (1) September tends to be a difficult month for the markets. (2) The Federal Reserve suggested last week that rates will remain higher for longer. (3) Strikes have continued among three large groups of workers. (4) A potential government shutdown looms on the horizon.

First, let’s address seasonality. Markets have been hit hard this month, as is typical in September. The good news is, after September, the market tends to do quite well up through the “Santa Rally” in December. Historically, December has been the strongest month of the last quarter of the year, although this trend has diminished in recent times.

Last week’s remarks from the Fed also influenced market performance. The Fed discussed the need to keep rates higher for longer, with potentially one more rate increase before the end of the year. Market reactions were pronounced: Bond yields rose, with longer-term maturities experiencing the most significant gains. Stocks dropped sharply for the week.

Interest rates are still on a downward trajectory, but the descent is taking longer than expected, which could result in added downward pressure on the economy. The Fed has slightly increased its GDP forecasts and decreased its unemployment projections, reflecting a somewhat more hawkish stance. Some economists have suggested that the Fed might be a little late to the party and that the market slowdown is already gaining momentum.

In response, yields have risen. Both the two-year and 10-year rates are at their highest levels in this rate cycle. The market had previously assumed that these rates had already topped. However, it now appears that while we’re near the end of the current cycle, they may not have reversed course yet.

Also affecting the market last week were strikes by the Screen Actors Guild-American Federation of Television and Radio Artists (SAG-AFTRA), the Writers Guild of America (WGA), and the United Auto Workers (UAW). The WGA appears to have made a breakthrough and called off picketing as of Monday (September 25) morning. SAG-AFTRA and the WGA represent a significant portion of the entertainment sector, and their strikes are largely bringing the entertainment industry to a halt. Estimates are that the current strike has cost the economy upward of $6 billion already, with further losses in the future. Additionally, the UAW strike has cost the economy roughly $1.6 billion in just the first week, with fairly targeted strikes expected to expand going forward. All of these represent lost wages and consumer demand, creating a significant headwind for the economy.

The final factor impacting the market last week was the threat of a potential U.S. government shutdown by the end of this week. House Republicans have struggled to reach a consensus as to what an acceptable budget looks like. Recent dysfunction in Washington led Fitch Ratings to downgrade the U.S. bond rating, and it appears the downgrade could be warranted. Should a shutdown occur, many government workers will not be paid (some will have to continue to work without pay), and most government contractors will also not be paid. These contracts alone could amount to nearly $13 billion per week, according to Bloomberg.

Despite all of these headwinds, an economic slowdown is not a certainty. The U.S. government has options to prevent a shutdown, the WGA seems to have reached a compromise with production studios (SAG-AFTRA may soon follow), and the UAW appears close to a viable agreement with Ford. So while each of these issues has the potential to significantly impact the economy, it is not certain they will do so, leaving room for the possibility of a “Santa Rally” in 2023.

Bonds

Treasury yields largely rose last week, with longer-term maturities increasing the most. The yield curve remains heavily inverted. The market appears to be anticipating higher rates for longer periods compared to the previous week.

Term yields increased and credit spreads decreased, indicating healthy economic expectations despite drops in risk-on securities. Overall, long-term Treasurys underperformed high-yield bonds, and longer-term bonds underperformed shorter-term bonds.

Gold

Spot gold gained only 7 basis points last week. This was likely due to conflicting market events: Interest rates rose last week, making the metal relatively less attractive than fixed-income securities. However, stocks also fell, which was in line with traditional safe-haven-seeking investor behavior. These effects appear to have offset each other for the week.

Non-currency safe-haven assets, such as long-term Treasurys, were down for the week.

Flexible Plan Investments (FPI) is the subadvisor to the only U.S. gold mutual fund, The Gold Bullion Strategy Fund (QGLDX), designed at its introduction 10 years ago to track the daily price changes in the precious metal.

The indicators

Our Political Seasonality Index was out of the market for the week, avoiding typical seasonal losses for this period. (Our QFC Political Seasonality Index is available post-login in our Weekly Performance Report section under the Domestic Tactical Equity category.) The very short-term-oriented QFC S&P Pattern Recognition strategy’s equity exposure started the week with little exposure, changing to 0.9X on Tuesday’s close, 1X on Wednesday’s close, 0.1X on Thursday’s close, and 0.6X on Friday’s close to begin this week.

Our intermediate-term tactical strategies are mixed in exposure. The Volatility Adjusted NASDAQ (VAN) strategy began the week 200% long, changing to 180% long on Monday’s close and 160% on Thursday’s close. The QFC Self-Adjusting Trend Following strategy began the week with 2X exposure but changed to 1X long on Wednesday’s close. The Systematic Advantage (SA) strategy began the week 90% long. It changed to 30% long on Monday’s close and neutral on Tuesday’s close, missing much of the week’s market losses.

Our Classic strategy was fully invested for the week. The strategy can trade as frequently as weekly, but signals are generally longer term in nature.

Flexible Plan’s Growth and Inflation measure, one of our Market Regime Indicators, currently indicates a Normal economic environment stage (meaning an increasing inflation rate and positive quarterly GDP reading). Historically, an Ideal environment has occurred 60% of the time since 2003 and has been a positive regime state for equities, gold, and bonds. Gold tends to outpace equities on an annualized return basis in a Normal environment, albeit with higher risk, while bond returns tend to be positive but fairly low.

Our S&P volatility regime is registering a High and Rising reading. This environment favors equity over gold and then bonds from an annualized return standpoint. The combination has occurred 23% of the time since 2003. It is a stage of relatively low returns for all three asset classes.