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September, Third Quarter 2023 Review & Outlook

market intelligence desk
The Market Intelligence Desk Team Market Intelligence Desk

Executive Summary

  • U.S. equities declined the last two months for their first quarterly decline since Q3 2022
  • The greenback advanced eleven straight weeks for its 2nd longest streak in 50+ years
  • Energy prices surged, led by a 29% gain in WTI crude
  • Long rates posted their biggest quarterly advance since 2009
  • Markets pricing a 35% probability for one additional rate hike this cycle
  • S&P 500 corporate earnings expected to be flat following three declining quarters 
US Indices Performance

August and September have a reputation for being “seasonally weak” as they are the two worst-performing months on average since 1970. Over that 50+ year period, September is the only month with a negative average monthly return. In that regard, the major U.S. equity benchmarks did not disappoint with declines in each of the final two months in Q3, which was also their first quarter in the red since Q3 2022. The Dow Jones Industrials was the best relative performer in both September and Q3, while the smaller cap Russell Microcap and Russell 2000 indices were the worst.

At their July highs, both the Nasdaq-100 and S&P 500 came within 5% from the prior all-time highs set in late 2021 / early 2022. After the recent weakness ending Q3, the Nasdaq-100 stands +41% from its 52-week lows. Conversely, in the last week of September, the Russell Microcap Index broke a 15-month support level to a new cyclical low while the Russell 2000 resided in the lower third of its prior 15-month trading range.

Nasdaq-100 vs. Russell Microcap

As has been widely reported throughout the year, the robust YTD gains in the large-cap benchmarks are being driven in large part by a small group of mega-cap companies. The “Magnificent 7,” as they have come to be known, have a 43% and 27% weighting in the Nasdaq 100 and S&P 500 indices, respectively, and the Bloomberg Magnificent 7 Total Return Index is +84% YTD.

Bloomberg Magnificent 7 Index

Accordingly, the cap-weighted benchmarks are grossly outperforming their equal-weight brethren. The Nasdaq-100’s 35.4% YTD total return is nearly double the 18.1% of the Nasdaq 100 equal weight index. The S&P 500 has a 13.1% YTD total return, while the S&P 500 equal weight index is only +1.8% YTD.

NDX total return

Sector Performance

Sector performance total return for September

A tale of two tapes can also be seen at the sector level, where five of eleven sectors are in the red YTD. Communications and Technology are +40.4% and +34.7% YTD, respectively, whereas the defensive Utilities and Consumer Staples are down 14.4% and 4.8%, respectively, on the year. In an environment where 12M T-bills are yielding over 5%, higher-yielding defensive sectors are relatively less attractive versus the ZIRP era. Ten of the 11 S&P 500 sectors declined in September, and nine of 11 were down for all of Q3. Energy and Communications outperformed the quarter, while Utilities, REITs, and Healthcare were the laggards.

Diverging performances are not only evidenced between sectors but also within them. While Communications, Technology, and Discretionary are the top three performing large-cap sectors, each of them is far outperforming their small-cap Russell 2000 benchmarks. Conversely, the small-cap Russell 2000 Energy and Industrials benchmarks are far outperforming their large-cap S&P 500 benchmarks.

S&P 500 vs. Russell 2000 Sector Performance YTD Total Return

Rates, Commodities and the Dollar

The recent decline in the stock market coincided with normal seasonal trends and was arguably overdue given the historic run in the 1H of 2023, including a record 39.4% total return for the Nasdaq 100 and a stellar 16.9% for the S&P 500. However, activity in the other three primary asset classes (rates, commodities, and FX) created additional headwinds for equities.

In the rates complex, the UST 30YR Yield surged 84bps in Q3 for its largest quarterly gain in more than 14 years while reaching its highest level since 2011. The UST 10YR Yield advanced 74bps in Q3, and its peak at 4.69% marked a 16-year high. With the Federal Reserve at or approaching the end of its rate hike cycle, the shorter-end UST 2YR Yield rose a relatively modest 15bps. Accordingly, a bear steepener has been underway throughout Q3. After bottoming at -108bps in March and June, the 10s, 2s UST spread has since been steepening. In the last seven sessions following the September 20th FOMC, the spread steepened an additional 30bps to close the quarter at -47bps.

Rising UST yields were accompanied by a broader rise in yields across the globe and coincided with actions taken by global central banks, regulators, and rating agencies. On July 28th, the Bank of Japan loosened its yield curve control (YCC) policy, a pillar of the central bank’s efforts to limit borrowing costs and stimulate the economy. Yields on 10YR JGBs then jumped to their highest level since 2014, leading to higher yields across the globe. On July 31st, the US Treasury issued its QFR (Quarterly Funding Report), announcing a sharp increase in the government’s net borrowing estimate for the July through September quarter to $1 trillion, well up from the $733 billion amount it had forecasted in early May. Soon after, on Aug. 2, Fitch downgraded the U.S. credit rating. 

10 YR, 2YR Spread | 10YR, 3M spread

In the commodity complex, energy prices have been soaring on the back of extended supply cuts by OPEC+ and Russia. WTI crude rose 29% in Q3, or as much as 40%, from the final week in June to the late September highs. Rising energy prices tax consumers and corporations at the expense of future economic activity and reduce the likelihood of a soft landing. Gas and heating oil rose 41% and 37%, respectively, while EU natural gas rose 13%. Precious metals were soft, with gold and silver declining 4% and 2%, respectively. Industrial metals were mixed in Q3 with aluminum +7% and palladium +3%, but nickel (-8%), steel (-3%), and copper (-0.1%) finished lower.

The U.S. Dollar Index (DXY) closed out Q3 with a streak of eleven consecutive weekly gains, its 2nd longest streak in 50+ years and reaching fresh 2023 highs. While the greenback’s ongoing streak of gains is impressive and needs to be kept on the radar given its strong inverse correlation to the S&P 500, the DXY gained a relatively modest 3.2% for the quarter. The dollar rose against nine of ten G10 currencies, as well as most EM currencies.

DXY Currency

According to FactSet, Q3 earnings for the S&P 500 are expected to decline 0.2%, marking the fourth straight quarter of YoY declines. For Q4 2023, analysts are projecting earnings growth of 8.2% and revenue growth of 3.8%. In Q1 2024, analysts are projecting earnings growth of 8.6% and revenue growth of 4.7%. The S&P 500’s forward 12-month PE ratio is 18, which is below the five-year average of 18.7 but above the ten-year average of 17.5. Valuations have come in but are still supported by expected 2024 earnings growth of 12.2%.

The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. All information contained herein is obtained by Nasdaq from sources believed by Nasdaq to be accurate and reliable. However, all information is provided “as is” without warranty of any kind. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.

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