- Seasonal headwinds arrived on cue in September, causing the S&P 500 to have its worst monthly performance since March 2020.
- Political and regulatory risks have risen sharply in the U.S. and China.
- A global energy crunch is roiling commodity markets.
- The Bloomberg Commodity Index is having its largest annual gain in 42 years.
- Global M&A and U.S. IPOs have already reached record levels with still one quarter to go.
Broad U.S. equity benchmarks were down across the board in September in what is seasonally the worst-performing month for equities. September ranks as the worst-performing month for the S&P500 over both the last ten and 20 years, and it is the only month with negative average returns over each period. Accordingly, September 2021 was the S&P 500’s worst-performing month since the height of the pandemic in March 2020, while the second-worst performing month over this 18-month period was September 2020.
Falling sentiment was headlined by systemic risk from China’s Evergrande crisis and its potential negative impact on the broader real estate market. China’s government has also been reinforcing state power through broad regulatory reforms, raising concerns it may lead to wider economic damage. Additionally, China is facing a power crunch which is impacting factories and homes. The shortage is crimping economic growth forecasts and roiling global commodity markets. China’s most recent PMI data (September) offered a mixed picture. Manufacturing PMI slipped to 49.6 from 50.1. It is the first sub-50 reading since February 2020. However, the non-manufacturing PMI was better than expected, pushing back above 50 to 53.2 from 47.5 in August.
Locally in the U.S., Washington has moved to the forefront for investors and is already having a greater than average impact on markets and the economy. This week the U.S. Congress passed a stopgap spending bill permitting the government to stay open until Dec. 3. The extension will allow politicians to focus on raising the debt ceiling and passing President Biden’s stimulus initiatives – a $1.2 trillion infrastructure (PAVE) plan and a $3.5 trillion “soft” infrastructure plan. The $1.2 trillion infrastructure bill has bipartisan support and has already passed the Senate; however, full passage has been delayed as moderate and progressive Democrats negotiate over terms of the “soft” bill. The “soft” infrastructure plan is more contentious, and the final bill will likely be reduced to a range of $1 - $2 trillion. The “soft” plan will expand the childcare tax provision and spend on green energy and other social programs. It will be financed with “modest” changes to the tax code, including U.S corporates, the highest individual income brackets, capital gains, and modifications to the SALT deductions. While a government shutdown is unexpected and default risk low, the process is fluid and likely to be disruptive for markets in the weeks ahead.
Following last Wednesday’s Federal Open Market Committee meeting, Chair Jerome Powell said the central bank could begin tapering as soon as their next meeting in November. He noted that the “liftoff” for rate hikes would likely not commence until after the taper process is complete, which could happen by the middle of 2022. Powell refrained from using the term “transitory” to describe his inflation outlook at this week’s annual appearance to the House Committee on Financial Services; however, his longstanding viewpoint on rising prices has not changed. Despite consumer price inflation running at 5.3% in August, Powell said he expects to see relief in the coming months and over the course of the first half of 2022 and that inflation expectations are still at levels consistent with the central bank’s 2% inflation target. It is worth noting that the Bloomberg Commodity Index (+29% YTD) is having its largest annual gain in more than 42 years (1979). Separately, President Biden can fill four Fed Governor seats over the next six months. Biden has until the end of February to appoint Fed Chair Powell to a 2nd term, but he could announce his decision for Chair and Vice Chair before year-end to appease different factions of the Democratic party. Powell has bipartisan support in Congress and is largely expected to be reappointed to another term. PredicitIt.org has Powell as a 75% favorite.
The capital markets are scorching, with record activity on the M&A and IPO front. Q3’s global M&A activity produced deals worth more than $1.5 trillion, +38% YoY and setting the highest quarter on record. Global M&A activity through the first nine months of 2021 reached more than $4.3 trillion, which already exceeds the annual record of $4.1 trillion made in 2007, according to Refinitiv data. Meanwhile, there have been a historic 770 U.S. IPOs over the first three quarters of 2021, which is already more than 3x the ten-year average of 205. While SPACs make up 58% of this year’s IPOs, the 323 non-SPAC IPOs alone are greater than any year since at least 2008.
On a total return basis, the flagship S&P 500 ended a streak of seven consecutive months in the green with a decline of 4.7%. The relative outperformers were the small-cap Russell 2000 and Russell Microcap indices, with declines of 2.9%. The Tech / Growth heavy Nasdaq 100 index underperformed with a decline of 5.7%.
Value (-3.5%) outperformed Growth (-5.6%) by 2.1 percentage points. Nearly all of Value’s outperformance occurred in the final week following the Sept. 22 FOMC, which coincided with long rates spiking higher. The below Growth / Value ratio (monthly) peaked in August 2020, at which point its RSI, measure of momentum, reached an extreme 92 “overbought” reading. The ensuing pullback found support at the prior high from the 2000 dot-com era, but upside momentum is fading, with the ratio now at risk of cementing a lower high.
Ten out of 11 sectors finished lower in September, including five sectors with declines of more than 5%. Energy was the lone sector in the green registering a total return of 9.4% and +43.1% YTD. Just one month ago, all 21 members of the S&P 500 Energy Index were trading below their respective 50-day moving average, and last week that figure rebounded to 100% trading above. Financials declined a relatively modest 1.8%; however, green shoots were visible amongst the regional bank subindustry, with the KBW Index (KRX) gaining 3.2%. Another subindustry standout was the Airline Index (XAL) which gained 2.8%; however, the broader DJ Transportation Index declined 4.4%.
The Bloomberg Commodity (BCOM) gained 5% in September, marking its 14th monthly gain over the prior 17 months. It now stands at +29.1% YTD, which currently represents its largest annual gain since 1979 (42 years). Natural gas has gone parabolic with a monthly gain of 34% and +134.9% YTD. WTI crude gained 14.1%, +55% YTD, for its highest monthly close since 2014. A consortium of factors on both the supply and demand side are driving energy prices higher with seemingly little end in sight. The summer driving season saw record-high gasoline demand in the U.S. Supplies were negatively impacted by hurricanes. China demand is strong and recovering from August fears surrounding the delta virus. And markets are pricing in a cooler winter.
For the fourth consecutive month, WTI crude is consolidating along the $75 – 77 range, which has been a critical price level representing major highs and lows on numerous occasions over the last ten years. This range initially marked major lows in 2011 and 2012 before later giving way to the “Thanksgiving Day Massacre” crash in November 2014 (OPEC / U.S. shale war). WTI returned to this level from the downside in mid-2018 but failed to break through after repeated attempts over a four-month period. An upside breakout this time around would signal a resumption of the prior uptrend with the potential for increasing momentum.
Inflationary forces are spreading with the generic cotton contract (CT1 Comdty) rising 14.8% in September, its largest monthly gain in over five years, and now +38% YTD. More importantly, the September price action made a “bullish breakout” above a near 10-year, clearly defined resistance line. From a technical perspective, breakouts above major multi-year price levels bring with it an expectation for powerful, long-lasting momentum. “The bigger the base, the higher into space.”
The 10YR UST Yield broke higher from a six-week base and finished September with a net rise of 18bps to 1.475%. The upside breakout came one session following the Sept. 22 FOMC and coincided with a second consecutive rise in weekly jobless claims. The rate spike is credited for the end-of-month weakness in growth stocks and rebound in financials. The 10YR / 2YR UST spread widened 11bps to 1.21%, while the 30YR / 5YR UST spread narrowed 7bps to 1.08%.
The U.S. Dollar Index (DXY) rose four straight weeks in September for a monthly gain of 1.7%. More than half those gains took place over the final four sessions, which registered a bullish breakout from a common “double bottom” price pattern formed over the first three quarters of 2021. The width of the pattern projects a minimum measured move to $97.35, up more than 3% from here. The projection is based on classic technical charting, not a Nasdaq forecast.
Going forward, there are reasons to be cautious on the near-term outlook for the broad, large-cap benchmarks. The S&P 500 declined 3.3% over the final four sessions in September. If it finishes Friday, Oct. 1 at that level or worse, it will represent the biggest weekly decline since the week before the 2020 Presidential election (eleven months). That in and of itself is seemingly not of great concern and arguably a BTD opportunity for some; however, Thursday’s 1.2% decline broke a nine-week support level of a classic topping/continuation pattern. The size of the pattern projects a minimum downside move to the 4,200 level, down 2.5% from Thursday’s close and less than 8% from the 52-week high. That is your typical correction seen in most years and less than the 10.5% seen last October 2020, which many investors may not even remember.
Looking underneath the hood of the broad equity benchmarks provides a more insightful perspective. While the large-cap indices are still within 5% - 6% of the highs, 71% of the member within the S&P 500 have already seen a correction of at least 10%, while 29% have pulled back more than 20%. The small-cap Russell 2000 has already seen 88% of its members decline more than 10%, while 70% have declined 20% or more.
A logical argument could be made that the long-awaited correction has already taken place for most publicly traded companies, particularly amongst the small caps. The Russell 2000 rebounded 144% off its March 2020 lows to its 52-week high reached in March 2021. Over the ensuing six months to date, it has been trading in a clearly defined, sideways range without breaking down any major support levels. In general, it is common technical price action for extreme price moves to be followed by long periods of consolidation. This fits the bill for the current setup in the Russell 2000, which has resulted in its weekly momentum (RSI) resetting from a high, overbought 78 reading reached in Q1 to a now neutral reading of 48. Until there is a breakdown below the ~2,160 weekly support, the technical setup for the small-cap benchmark is not yet concerning.
One final noteworthy setup is the relative strength of large caps to commodities. The ratio of the S&P 500 to the Bloomberg Commodity Index bottomed in mid-2008 and has since been trending higher, reflecting the longer-term outperformance of stocks vs. commodities. The ratio peaked in June 2020 and a bearish divergence formed with the weekly RSI peaking four months earlier. After spending the last 17 months in a clearly defined sideways range, the ratio broke down below its support in the final week of September. Despite this recent breakdown, the weekly RSI, now 35, is already in deep bearish territory representing a ten-year low. If downside follow-through continues, commodities could be in the early stages of outperformance versus large-cap equities. On an absolute basis, this is not a concern for stocks, but it could signal a more lasting rotation is coming amongst various sectors of the stock market.
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