Financial markets lived up to their reputation during the past two months for being difficult, like children at the end of summer, when parents are counting down the days until school.  In early August, markets had to contend with a downgrade of U.S. long-term debt. This adjustment was attributed to the expected fiscal deterioration, a high and growing general debt burden, and the erosion of governance.  Many financial leaders characterized the downgrade as “ridiculous,” but the stock and bond markets still felt the effects. A further setback for markets came from credit downgrades for 10 small-to-medium-sized banks and 11 larger banks, with a warning of increasing financial risks in the form of higher interest rates, escalating funding costs, and rising risks to commercial real estate holdings.

Whoa, that is a lot to digest, and that was all before Labor Day.  September brought more volatility from a variety of sources such as seasonality, historically, September and October are the most volatile months of the year. In addition, the compounding negative news on a UAW strike, potential government shutdown, and rising yields, was the opposite of helpful.  Markets have struggled recently to find firm footing and navigate their way through the ongoing debate of the country’s financial strength. We still believe however, durability of corporate America is strong seen in better-than-expected earnings reports along with record low Unemployment data, keeping consumer spending resilient.

The housing market continues to defy higher mortgage rates, as the low inventory of houses on the market supported elevated prices in third quarter. The National Association of Realtors’ chief economist noted that with a strong labor market, the pool of prospective buyers has been enlarged, but with rising mortgage rates and limited inventory, the possibility of home purchases may be “hindered for many.”

Resilience aside, the market still is experiencing volatility with a pullback in the stock market and higher bond yields—specifically the parabolic rise in 10-year yields to near 5% has significantly tightened financial conditions. This impacts all types of credit tied to longer term rates. This is very clear to the Fed Reserve as well.  This week alone we have started to hear more dovish talk on future interest rates from FOMC members Richard Clarida and Austan Goulsbee. To us, it looks like the bond market already did the work for the fed and if rates stay elevated, the FOMC has good reason to stand pat and wait for more data before another hike.

This morning, October 6th, we received economic data on jobs and wages for September, which we believe could be catalyst for a turning point.  We caution that monthly job numbers are volatile, and the actual result of 336,00 new non-farm payroll jobs was close to double the estimate and may cause a knee-jerk reaction to the downside for equities and upside for yields. Wages however were softer and the unemployment rate did not rise.  The negative reaction to this strong data we believe has the potential to reverse, and hopefully in the short term provide some reprieve for investors and a changing of the short term negative sentiment.

Downside risks have decreased as a result of the drawdown over the past 2.5 months.  With sentiment low, and pessimism high, the result was selling of equities.  We believe the selling has started to show signs of exhaustion and sets the stage for a reversal and a move higher as we move through the 4th quarter.

So where does that leave the market through year-end, we believe US Equity markets are nearing support.  More meaningful rallies might begin for both equity indices and treasuries starting in the near term through the end of the year.  Furthermore, this will be occurring when potentially receiving economic data confirming weaker conditions across many areas of the economy giving more ammunition for the federal reserve to remain on the sidelines longer.

Please reach out to me if you have any questions.  Stay safe, and stay the course.

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