By Deborah DeMatteo
Managing Director & Chief Investment Officer
After the gut wrenching roller coaster ride at the end of August, the start to September was relatively calm. As we enjoyed the last days of summer and Labor Day celebrations quickly transitioned into the first day of Fall, once again markets sold off. The month ended up adding to the losses for the year. We head into the final quarter of the year with all three major indices in the red; The DOW gave back 1.47% for the month and is now down 8.63% year -to-date, the S&P 500 was down 2.63% brining its losses to 6.74% ytd., and the NASDAQ was down 3.27% taking that index now into the red for a loss of 2.45% ytd.
September was all about the Federal Reserve with the Federal Open Market Committee’s two day meeting in the middle of the month. This meeting was touted as one of the most important decisions in Federal Reserve history regarding its interest rate policy. The markets were very equally divided going into the meeting and it seemed clear that no matter what decision was reached, it would be difficult for the markets to have a positive response. The two day meeting concluded with no change to interest rates.
For most of us, it seems hard to believe that after such an extended period of a zero interest rate monetary policy, that a move to possibly .25% could cause such worldwide attention and turmoil. What we need to be mindful of is that the first move will not just represent the first move toward monetary tightening that we have seen in nine years, but more importantly the beginning of a new cycle. The last time the Fed raised rates they continued to do so for a period over two years, beginning in June of 2004 and ending in August of 2006. The period prior lasted from June of 1999 through July of 2000. It is interesting to note that although the market fears higher rates, twelve months from the start of raising rates in both of the last cycles, stocks ended higher. This time the fear lies in the level from which we are starting, the lack of strength in the US economy, weakness in global economy, and the unprecedented events and policy that have gotten us to this point.
Can we really blame the Fed? If you look at the chart above, the decline for stocks began on the 18th of the month precisely the day we got the no change decision from the Fed. Until the most recent decision, investors have applauded the Fed for keeping rates at zero and the market would rally when they announced a no change strategy. Should we therefore expect that the subsequent announcement not to raise rates will be met with a rally? If only it was that easy! What we have now is more uncertainty surrounding the factors that will push a decision to raise rates which leaves investors with greater questions regarding the timing by the Fed. For the first time, the Fed referenced global conditions as a factor weighing on their decision. This begs the question, “What other indicators may they take into consideration going forward in setting future policy?” Although they left the door open to a rate hike before year’s end, a few months is very little time to expect any dramatic change in the global economic conditions. As long as the Fed remains data dependent, the markets will try to predict Fed policy with every piece of relevant data. What investors seek most is clarity, what they received after the September meeting was more uncertainty.
If we move away from the Fed, we can justify the jitters in the market with some of the other variables and the mixed economic data that we see. Let’s start with some positives; the auto industry continued the pattern of strength we have seen so far this year. As a whole, it is projected that sales will top 18 million, the highest number since 2005. All major manufacturers saw a strong month except Volkswagen, which is embroiled in a scandal regarding manipulative software installed on their diesel vehicles. Outside of that, we saw strong growth dominated by trucks, SUV’s, and crossovers. Ford saw overall sales up by 23% for the month, with their FSeries pickup truck, the most popular vehicle in the U.S., up 16%. Housing remains on track for a good year as well. Although the most recent data for housing starts was for August, U.S. Housing starts were up again running at a seasonally adjusted annual rate of 1.21 million, the highest since October of 2007. As stated by Amherst Pierpont Securities Chief Economist Stephen Stanley, “There is a lot going on in this set of numbers, but the bottom line is an explosively strong housing sector.”
We just got the September jobs report, which was disappointing to the market. With expectations around 200,000 jobs created, the actual number came in at only 142,000. The unemployment rate remained at 5.1% and the labor force participation rate continued to decline. Although we can attribute some of this to energy and mining, we are still not seeing the type of employment market representative of a robust recovery. This will certainly be a piece of data that the market will assume will keep the Fed from raising rates this year. This paired with the weak data out of China and the continued volatility in commodities can help to explain the lack of optimism in the market during September.
To top it off, there has been no help from the bond market. Treasury rates remain more volatile than normal, September being no exception. Tenyear treasury rate started the month at 2.22%, peaked at 2.29%, and finished the month at 2.04% representing an 8.17% decline. For corporate bonds, the market more relevant to us, we have seen risk premiums rise. Very simply put, investors are demanding a higher rate of return to lend to corporations which puts pressure on prices of existing bonds. Global economic weakness creates uncertainty about the future which makes investors more hesitant to make long term decisions.
Fear and uncertainty create opportunity. Market volatility is never welcome when it is to the downside. As we enter the 4th quarter and begin to get the earnings for the third quarter, it will begin to provide some clarity for year’s end. We will be looking for insight from the leaders of the companies that we choose to own, their pulse of the economy is what we need to pay attention to.