Autoworkers on strike. A looming government shutdown. Energy prices on a tear.
(Bloomberg) — Autoworkers on strike. A looming government shutdown. Energy prices on a tear.
One by one, fresh pressure points are building on Wall Street that threaten the bullish narrative that a soft economic landing can be secured in this menacing monetary era.
All that just sparked the worst month for the S&P 500 of this gravity-defying year in markets. At the same time an equal-weighted version of the index — where the likes of Expedia Group Inc. carry the same heft as Microsoft Corp. — has now shed nearly all of its 2023 gains, hurting active managers who failed to buy up the biggest blue chips in Corporate America.
Put another way, the Federal Reserve’s restrictive monetary policy is tightening financial conditions by design. The two-month damage to stocks thanks to even higher longer-term bond yields — while the US dollar soars — has pushed a Goldman Sachs Group Inc. index of cross-asset health to the most sluggish level of the year.
It’s a sign that the economic outlook is getting more challenging and risk appetite is enduring something of a reset.
“When you’re having these massive explosive moves in things like the value of the dollar and the Treasury curve, that’s what disrupts confidence in investing in equities,” said Art Hogan, chief market strategist at B. Riley Wealth. “It perpetuates that risk-off attitude.”
At the same time, there’s a new fear slowly creeping in among hedge funds and real-money investors who have recently pared back their equity exposures: That the once-fearless US consumer is beginning to buckle, with used-car dealers and major retailers issuing warnings on their earnings trajectories.
Should the US government shut down, non-essential operations would come to a halt at the start of October, just as a prolonged strike by automotive workers risks an economic slowdown. Oil prices have also pushed closer to $100 a barrel, stoking expectations that interest rates will stay higher for longer.
That’s why bond yields refuse to settle down. The rate on 10-year Treasuries at one point this week rose above 4.6%, the highest since 2007. It’s adding fuel to the S&P 500’s longest losing streak of the year — currently at four weeks — while the Nasdaq 100 has just notched a 5% loss for September.
In other words, the fraught relationship between stocks and bonds — which underpins the nervous system of Wall Street — continues. A three-month measure of correlations between the S&P 500 and benchmark Treasuries has climbed to the highest level since February.
“‘Higher for longer’ are the three most dangerous words for equity markets,” said Marija Veitmane, a senior multi-asset strategist at State Street Global Markets. “It feels like the stock market is increasingly driven by rates expectations in the last couple of months since higher-for-longer began to take hold in investors’ minds.”
Yet what’s driving the stock-Treasury link looks materially different now than last year, when long-dated bonds sold off and equities declined in tandem as the Federal Reserve was aggressively raising rates. These days, by contrast, the central bank is seen as being mostly done with its rate hikes. Instead traders are adjusting to the idea that Fed Chair Jerome Powell and his colleagues want to see long-term borrowing costs adjusted for inflation increase further.
The issue for equities in this world is that the market hasn’t figured out where rates will settle and the subsequent impact on economic growth and corporate earnings, according to Nicholas Colas, co-founder of DataTrek Research.
Some investors aren’t waiting around. Those who hiked their equity exposure to overweight earlier this year have now sharply cut risk and are moving closer to neutral positioning, according to Deutsche Bank Group AG data.
That includes the likes of Nathan Thooft in Boston.
“We have over the past month or so been taking equity risk off the table, driven by a combination of deteriorating technicals, sentiment and increasing fundamental risks as well as policy uncertainty with the Fed and fiscal government shutdown,” said Thooft, global head of asset allocation at Manulife Asset Management.
It’s not all bad news, clearly. Stock gains for the year are still at double digits, the credit cycle is resilient and many investors have made peace with elevated yields.
In fact, if the labor strikes and government shutdown keep financial conditions tight that would aid the Fed’s bid to curb price pressures. And there was more good news on the latter front on Friday. Data showed the Fed’s preferred measure of underlying inflation rose at the slowest monthly pace since late 2020.
“The tightening in financial conditions led by long-term rates weakens the case for another rate hike,” said David Mericle, the chief US economist at Goldman Sachs Group Inc.
–With assistance from Cecile Gutscher.
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