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We enter September with mixed results coming in on economic reports, a resurgence in Covid-19, and some major geopolitical shifts.
The S&P 500 is trading near all-time highs, having closed August at 4522.68. Historically, the month of September is the worst of the year in terms of stock returns, and October has had a fair share of market slides as well. After a brief spate of volatility in August, the markets returned to placidly climbing after only a 2.5% drop. The VIX volatility index is currently at 16, which implies that daily moves of 1% or under are expected over the next 30 days. It is important to note that volatility tends to move in sharp spikes, so this apparent calmness in markets could give way quickly if some significant catalyst emerges. It has been an entire year since the last 10% pullback in the market, and this is unusual. As a result of the points noted above, we are expecting markets to become more volatile and see the risk of a correction in equity prices as being elevated. Nevertheless, any such pullback is expected to be temporary.
On the economic front, it seems that while the Federal Reserve is continuously calling for “transitory” or “muted” inflation, sentiment among market participants and the actual data is suggesting otherwise. Consensus expectations of analysts show an expectation of 3% in the Core PCE (personal consumption expenditures), with a low forecast of 2% and a high forecast of 4.1% for 2021. There are other data suggesting that recent Covid concerns may have dampened consumer expectations, as the University of Michigan Consumer Sentiment Index declined by 13.42% from 81.2 to 70.3. This is a decline of substantial magnitude in a short time, although the lower sentiment is not expected to persist. The most recent ADP Employment report shows the economy added only 374,000 jobs against expectations for 613,000. While these reports are concerning, the underlying economic conditions do not indicate any strong likelihood of a pronounced or prolonged slowdown in economic activity. Real GDP is forecasted to climb by 6.2% for 2021, which is more than 3X the expected normal growth rate in a highly developed economy like that of the United States.
Interest rates are modestly higher from a month ago, with 5-year paper up 7.2 basis points, 10-year paper up 6.7 basis points and longer-dated maturities are basically flat. This is not particularly meaningful and indicates that market participants in general (for now) believe the Federal Reserve’s assessment, that inflationary pressure is going to be temporary. With that said, the MOVE index, which measures volatility expectations in Treasuries in the same way that the VIX index does for stocks, is elevated and trending up. This signals that investors are buying protection from rising rates and augurs a potential move higher on the horizon.
It is said that “the market climbs a wall of worry.” While we see elevated risks in markets going into the fall, we continue to advise investors to keep the big picture in mind and not trade short-term events in a long-term investment plan.
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