It had all been going so nicely, hadn’t it? After seven consecutive months of positive returns in the stock market, was it too much to ask for just one more? Apparently it was, as after mostly uninspired, price action for much of September, investors threw in the towel the last week of the month. From the end of trading on 9/24 through the close on 9/30, the S&P 500 had a (3.30%) total rate of return, the Russell 2000 Index (small cap) returned (1.90%), and the S&P Midcap 400 Index limped home with a less than impressive (2.14%) effort.
It felt like doing the dishes after a successful dinner party, only much worse. But what happened? Would it sound crazy I said complacency was a contributing factor? Investing had gotten, arguably, a little too easy.
From the 10/31/2020 through 8/31/2021, the S&P 500 posted a 40.05% total return, with only one monthly hiccup in January. With the Federal Reserve flooding the financial system with liquidity and the Treasury spending money it didn’t have, let alone interest rates hovering near rock bottom levels, investors did the most prudent thing: they invested in stocks. God was in His heaven, and all was right with the world.
As I have written in this newsletter in the past, and as I have told countless others, US stocks are the most reasonably valued of all overvalued asset classes. If I felt this way before September’s swoon, I certainly feel the same way now, all the more. If that is the case, why did the markets freak out last month?
We can point our collective finger at this or that reason. From the Fed potentially tapering their asset purchases to the mess with Evergrande in China to delays with the infrastructure package and dysfunction in Washington to slightly softer (but still strong) economic data to elevated ‘relative strength indicators’ to an increase in longer-term interest rates to you name it, there were a lot potential bricks in the wall of worry. That is if you are prone to worrying.
With that in mind, have you ever been in a situation where everything seemed easy, perhaps a little too easy? A little too comfortable? You know, that round of golf where you didn’t make any mistakes? The sporting clay course which was inexplicably easy on a particular day? There are any number of examples, and they all have one thing in common: you likely weren’t worrying, questioning your good fortune, and/or overanalyzing what you were doing. That is until you started to do so, am I right? What happened next? Things were quite as easy, were they.
I don’t consider myself much of a worrier. However, I also seem to have a fair number of opinions about myself which others don’t necessarily agree. So, maybe I am, and perhaps I gave this trait to my son who is more of a worrier. He has told me he worries he is going to mess up or otherwise make a mistake. I ask him what normally happens when he worries, and the answer is obvious. So, I tell him: “well, it seems like worrying is a self-fulfilling prophecy, doesn’t it? So, why do it?” It is a great question.
The question you might have is: “are you for real, Norris? Are you honesty saying worrying was the reason why stocks took it on the chin this past week, even month? There has to be more to it than that.” Indeed, that is exactly what I am saying. People began thinking too much which led to worry which led to red ink. After all, what has fundamentally changed in the US economy or markets to warrant a 4.65% sell-off in the S&P 500 last month?
Did the Fed start tightening credit? Did the yield curve invert? Is the cash market not operating properly? Has the economic data fallen off the proverbial table? What is it? What has fundamentally changed in the markets, financial system, or the economy to warrant such a bad month? The answer is pretty simple: absolutely nothing.
Yes, 10-Year Treasury yields ticked up during the month…but only to close about where they were on 6/30/2021 and 0.25% less than they were at the end of the 1st Quarter. Further, the yield to maturity on the 10-Year at the end of the 3rd Quarter was 1.488%, whereas the most recent trailing 12-month Consumer Price Index is 5.3%. That works out to be a (3.8%) differential.
To put that number into perspective there have 717 months since, and including, January 1962. That (3.8%) difference between two ranks 707, which means it is about as wide (negatively) as it ever has been. In other words, money is about as cheap as it can get, even with a slight back up in interest rates. You can say, money got a little less free during September, which is sort of comical.
Moving forward, the upcoming earnings season is going to be extremely important. There are no two ways about it. It will likely set the tone for the stock market for the remainder of the year, as significant multiple expansion from these levels, at this time, seems unlikely. So, just how did corporate America perform last quarter? The low hanging fruit is: US corporate profitability was significantly better during the 3rd Quarter of 2021 than the stock market’s performance indicated.
As a result, we are putting last month’s unpleasantness behind, and focusing on making money during the remainder of the year. Hey, IF we liked US stocks before September, we must really like them now, right? Let me just say, it is a beautiful day outside, all the elements are in place for a successful final 3 months of the year, and we are going to get after it.
So, let me leave you with this one, from John Lubbock: “A day of worry is more exhausting than a week of work.
Take care, thank you for your continued support, and be sure to listen to our Trading Perspectives podcast.
Chief Economist
As always, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our investment committee, are subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the reset of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.