September Market Review
In September, and throughout the third quarter, we were reminded that increased interest rates can have a significant impact on global markets. During this period, cash continues to be a crucial asset class, as both equity and fixed income markets faced challenges. Aside from concerns about a possible government shutdown, which ultimately did not materialize in September, the primary focus for investors was on the actions of the FOMC and the incoming economic data.
During September, all sectors of the S&P, except for the energy index, experienced declines. The information technology and real estate sectors recorded the most significant drops, down approximately 7%, largely due to their historical negative correlation with rising interest rates. Despite the challenging quarter, equity markets continue to shine in the context of asset allocation models. The S&P’s total return for the year remains above 13%, and the Nasdaq has rebounded impressively, boasting a 27% gain in 2023.
As previously mentioned, the notable increase in interest rates along the US yield curve played a pivotal role in the downturn of the markets.
Short-term treasury bills held steady at around 5.5%, which the yield curve exhibited a “steepening” trend across various maturities. US 2-year treasury notes, for instance, rose by 18 basis points last month, resulting in a yield of 5.05%.
The US 10-year note saw an even steeper increase of over 46 basis points, leading to a yield of 4.57%.
Longer-term bonds, including the US 30-year benchmark bond, also saw a significant rise of 49 basis points, yielding 4.70%.
Bonds maturing in over 20 years experienced an almost 8% decline during the month.
These moves in long-term interest rates represent cycle-high yields and market the first time the benchmark 10-year yield has surpassed 4.50% since 2007. Several factors contributed to these developments, including expectations of a soft economic landing, data on inflation, the Federal Reserve’s vigilant stance, and increased supply at auctions, all of which pushed bond prices down.
Consequently, many broad fixed income indices have posted negative returns for the year 2023. On the other hand, cash-like and shorter-duration portfolios have remained positive due to their higher income stream and less severe price fluctuations.
Credit sectors faced even more significant losses than government bonds in September. While investment-grade corporate bonds had been a beacon of stability in the bond market this year, the trend reversed in September as credit spreads widened in response to declining equity markets. Bonds with ratings of A, AA and BBB saw declines of over 2.5%. High-yield bonds also experienced modest declines but continued to perform better than the investment-grade sector. Emerging market bonds were not immune to the downturn, falling by over 2.5%. Corporate bond issuance in September slightly exceeded consensus expectations, reaching $124 billion in new issuances. Interestingly, the percentage of new issues that tightened in spread (increased in price) upon issuance has been decreasing recently.
Municipal bonds, on the other hand, emerged as one of the worst-performing segments within the investment-grade sector. The previously high valuations in tax-free municipal bonds finally saw a swift reversal in September. Many broad municipal bond indices witnessed declines of nearly 3% during the month, prompting fund outflows as interest rates surged. The municipal yield curve experienced a rise of over 50 basis points, and some longer-term high-grade yields reached over 4%, marking the first time in many years that tax-free yields have reached such levels.
Data Recap
The FOMC statement on September 20th remained largely unchanged from the one issued on July 26th. It noted that economic activity had been growing steadily, with a slight slowdown in job gains in recent months but still a robust overall employment situation. Chairman Powell reiterated the possibility of further interest rate hikes if inflation persisted at elevated levels. This message was not well received by the market, leading to a continued decline in bond prices as investors grappled with the reality that the Fed was not planning to east its monetary policy anytime soon. As of the end of September, the likelihood of a rate hike on November 1st remained low. The October economic data and the prevailing market sentiment of “expecting higher rates for a longer duration” would play a crucial role in the Fed’s decisions.
September’s jobs data exceeded expectations, but revisions to previous months revealed a clear hiring slowdown, even though the unemployment rate remained low at 3.8%, indicating full employment. Average hourly earnings saw a slight dip, and job growth continued to decelerate, reinforcing the possibility of a gradual economic slowdown.
In terms of inflation, there were some promising signs during the fall. Both CPI and PPI releases for the previous month were in line with estimates and did not show a significant spike, despite rising energy prices. Prices for goods in manufacturing and the service sector increased, suggesting that pricing power still existed. Unit labor costs and the PCE deflator also rose in the second quarter, but overall, inflation expectations remained on a downward trajectory.
The US consumer remained strong, with robust personal income, spending, and retail sales figures in August. However, the housing sector began to feel the effects of higher interest rates, with mortgage rates above 7% in the US slowing down the market. Housing indicators, such as the housing market index, housing starts, existing home sales, and new home sales, all showed declines in September, along with pending home sales falling month-over-month by 7.1%.
As the third quarter concluded, investors experienced a flashback to 2022, with cash being a preferred asset class, both equity and bond total returned in the negative for the month and the quarter. The government narrowly avoided a shutdown at the end of September, with Moody’s warning that such an event would be viewed negatively. Additionally, investors closely monitored China’s property sector, which continued to exhibit signs of turmoil. The fourth quarter began with a restrictive policy stance and high risk-free rates, leading to expectations of industries facing higher costs of capital and margin compression. These conditions made the bond market more attractive to income-seeking equity investors. Early indications from Amazon suggested that the holiday season would reach record levels, and consumer strength remained apparent.