Stocks got hit at the start of a historically tough month for the market, with investors bracing for economic data that will show whether or not the Federal Reserve will need to be aggressive with rate cuts.
Wall Street traders took risk off the table, with the S&P 500 seeing its worst slump since the Aug. 5 market meltdown. That’s after a rally that put the benchmark within a striking distance of its all-time highs. The gauge’s most-influential group — technology — sold off on Tuesday, with Nvidia Corp. driving a plunge in chipmakers. Energy shares tumbled as oil erased its 2024 gains. Wall Street’s “fear gauge” - the VIX - topped 18. Bonds climbed.
With inflation expectations fairly anchored, attention has shifted to the health of the economy as signs of weakness could speed up policy easing.
While rate cuts tend to bode well for equities, that’s not necessarily the case when the Fed is rushing to prevent a bigger US slowdown. The trepidation regarding the latest rise in the unemployment rate will leave traders “on edge” until Friday’s payrolls data is in hand, said Ian Lyngen and Vail Hartman at BMO Capital Markets.
“This week’s jobs report, while not the sole determinant, will likely be a key factor in the Fed’s decision between a 25 or 50 basis-point cut,” said Jason Pride and Michael Reynolds at Glenmede. “Even modest signals in this week’s jobs report could be a key decision point as to whether the Fed takes a more cautious or aggressive approach.”
To Callie Cox at Ritholtz Wealth Management, aside from the macro picture, there’s also the fact that we’re entering what’s often a “miserable time” of the year for equities.
“While history isn’t gospel, it’s not crazy to think that this September could be especially volatile,” Cox noted. “But this isn’t the conclusion to draw from decades of seasonal market data. Instead, your attention should be on why this is a “buyable dip, because there are a lot of reasons to be optimistic here.”
Among those, she cited: earnings growth, the Fed about to start easing policy against the backdrop of controlled inflation and the fact that investors are sitting on a massive pile of cash “that could make its way back into stocks.”
The S&P 500 dropped 1.6%. The gauge is drifting down toward 5,550, a level at which there’s large open interest in options expiring later this month, making that a level to watch. The Nasdaq 100 slid 2.5%. The Dow Jones Industrial Average fell 1.2%. The Russell 2000 of small firms lost 2.7%. Nvidia slumped 8%. Boeing Co. sank 7.5% on an analyst downgrade.
Treasury 10-year yields fell five basis points to 3.85%. A record number of blue-chip firms are swarming the corporate-bond market, taking advantage of cheaper borrowing costs ahead of the US presidential election. The yen climbed as Bank of Japan Governor Kazuo Ueda reiterated the central bank will continue to raise rates if the economy and prices perform as expected.
The Morgan Stanley strategist who foresaw last month’s market correction says firms that have lagged the rally in US stocks could get a boost if Friday’s jobs data provide evidence of a resilient economy. A stronger-than-expected payrolls number would likely give investors “greater confidence that growth risks have subsided,” Michael Wilson wrote.
The equity-market rally may stall near record highs even if the Fed starts a highly anticipated rate-cutting cycle, JPMorgan Chase & Co. strategists said earlier this week. The team led by Mislav Matejka noted that any policy easing would be in response to slowing growth, making it a “reactive” reduction.”
“We are not out of the woods yet,” Matejka wrote in a note, reiterating his preference for defensive sectors against the backdrop of a pullback in bond yields. “Sentiment and positioning indicators look far from attractive, political and geopolitical uncertainty is elevated, and seasonals are more challenging again in September.”
September has been the biggest percentage loser for the S&P 500 since 1950, according to the Stock Trader’s Almanac. A contrarian sentiment gauge from Bank of America Corp. rose to its highest level in nearly two and a half years last month — creeping closer to a “sell” signal for US stocks.
“For all years since World War II, August and September saw the S&P 500 endure a double-dose of declines,” said Sam Stovall at CFRA. “Yet history now advises investors to fasten their safety belts, since during election years, this sequential seasonal slippage has shifted to September and October.”
Rich Ross at Evercore says the S&P 500 has had at least a 5% drawdown from the August/September highs in nine of the last 10 years.
“This year should be no different after the late August squeeze into resistance at an all-time high,” Ross noted. The S&P has a strong downside bias buttressed only by a bent towards ‘low volatility’ defensives and financials — which benefit from lower rates and steeper curves.”
“A key lesson from the last few weeks is that big-tech stocks have not proven defensive during the recent market pullbacks,” said Philip Straehl at Morningstar Wealth. “While there is little evidence of a slowdown in AI spending, valuations have set a high bar for incoming corporate and macro data.”
Traders are projecting the Fed will cut its rate by a full percentage point by the end of the year, implying an unusually large half-point reduction at one of the three meetings left in 2024.
What’s more, they are anticipating that the central bank will reduce its benchmark rate by more than two full percentage points over the next 12 months, which would be the steepest drop outside of an economic downturn since the 1980s.
“The Fed is finally coming around to cutting rates, but it does not feel like stringing out a bunch of 25 basis-point rate cuts will do the job,” said Neil Dutta at Renaissance Macro Research. “That muddling through scenario will probably risk further increases in the unemployment rate. So, if they aren’t going 50 in September, they are going to need to go 50 at some point later this year.”
Marking the start of a busy week for economic data, a report showed US manufacturing activity shrank in August for a fifth month.
This coming Friday, the August jobs report is expected to show payrolls in the world’s largest economy increased by about 165,000, based on the median estimate in a Bloomberg survey of economists.
While above the modest 114,000 gain in July, average payrolls growth over the most recent three months would ease to a little more than 150,000 — the smallest since the start of 2021. The jobless rate probably edged down in August, to 4.2% from 4.3%.
US interest-rate strategists predict a bigger market reaction if Friday’s August employment data is weaker than anticipated, according to the limited quantity of weekly research reports published around the holiday weekend.
“With the Fed likely to begin its rate cutting cycle in September, investors should consider extending duration now in high-quality fixed income to capture potential gains,” according to Principal Asset Management. “Historically, bond yields drop ahead of Fed rate cuts, offering a window of opportunity to enhance returns without waiting for official policy shifts. Positioning in longer-duration assets now can provide income stability and potential price appreciation in a slowing economy.
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