“Sometimes we stare so long at a door that is closing that we see too late the one that is open.” ~ Alexander Graham Bell

Good evening:

Markets remain in what Fundstrat Head of Data Science Ken Xuan terms a “vortex of pain.” We opened on Monday with markets continuing to digest the previous week’s central bank actions (from the Fed, the Bank of England, and the Bank of Japan.) 

Last week’s FOMC meeting led to renewed fears among many market participants that the Fed would stay “higher for longer.” A continued surge in yields followed, weighing on the stock market. Fundstrat’s Head of Data Science, Ken Xuan, pointed out that the central bank’s quantitative tightening might also have contributed to yields climbing: during the week of September 18, the Fed reduced its balance sheet by $75B – the largest weekly decline since QT began. Part of this was achieved through a significant sell-off in Treasuries, possibly depressing prices and boosting yields.

Regardless of the reason for surging yields, Head of Technical Strategy Mark Newton began his remarks at our weekly huddle by noting that, “The biggest thing you have to understand that the equity market right now is that rates and equities are very inversely correlated and with rates moving up equities do not respond well. We’ve pushed up to almost 4.75% in the 10-year and so that is certainly a source of concern for the equity market.” 

From a technical standpoint, however, Newton argued that “there are some reasons to think that these yields are just getting too stretched. So ideally, what's going to happen is that probably as of next week, we see yields start to break, markets bounce, but then yields sort of churn. Then eventually, we peak out between October or November with a larger pullback in rates happening in the next year.”

He noted as an aside that, “There are some reasons to think [Treasuries]  are pretty good value here. I like TLT -2.53%  and IEF -0.68%  – even if you don’t catch the exact low, they represent a great value here not only to make money on yield but also in price appreciation.”

Returning to the stock market, Newton said that “Since September 1, momentum has turned negative. We are nearly oversold based on a lot of metrics, but we are nearing pretty good support which is right near the 4200 level. I don't think we're going to get down under that. To me, the risk-reward is increasingly good." He summed it up a bit more colorfully: “For those who like to buy and hold your nose, I think you'll be rewarded between now and year end, even if it's not right away.”

Although Fundstrat Head of Research Tom Lee was out this week on a much-needed vacation, Xuan and the Fundstrat team assessed the week’s data. They also concluded that our constructive base case for the rest of 2023 remains intact. 

Data showed apparently conflicting views on the housing market this week. “We saw pretty weak data regarding pending home sales and new home sales this week,” Xuan observed. But the July Case Shiller Home Price Index came in hot at 0.87% versus expectations of 0.70%. This was the first positive reading after four straight negative months. 

Xuan and the team found that this higher reading had more to do with the “base effects” of a methodology that excluded weak July 2022 data than with any strengthening of the housing market. We expect the same effect to cause the Case Shiller YoY figure to pivot higher in the next few months, but of the 20 cities that Case Schiller tracks, eight of them (40%) have housing prices in outright deflation. This is double the 20% average (since 1988), Xuan pointed out, “so in our view, the housing market remains cool.”

For stocks, “the battleground remains inflation,” Xuan said. As we expected, Core PCE again showed declining inflation. YoY, Core PCE came in below 4% for the first time since 2021, and MoM came in below Street expectations at 0.1%, the lowest that figure has been since November 2020. This provided continued evidence of our assertion that inflation is on a glide path lower.

On sentiment

“Sentiment is actually now more bearish,” Newton said. “It's taken almost two and a half months, but we've dropped from very bullish levels in July. Now we're extremely bearish on Fear and Greed. AAII is also now bearish by 13 percentage points.”

Xuan also pointed out that hedge funds recently added the most short-exposure, on a week-over-week basis, since the COVID-19 pandemic – a sign of weakening sentiment. Data from EPFR also shows equities had their largest outflows of 2023 last week. 

To us, this bearish sentiment is a bullish sign.

On seasonality

“We're approaching seasonally a much better time,” Newton told us. “When you look at the last four Septembers they were all down between 3.5 and 7%. But Q4 is anywhere up between 7% or higher. So we are coming into seasonally a very good time.” 

Xuan also pointed out that going back to 1950, when the S&P 500 is up >10% through July (as it was this year), but declines from July through September 23 (as it has this year), 4Q performance has always been strong – eight out of eight times, with any average quarterly return of 7-8%. “That’s a stunning 100% win ratio,” he observed.

What about the government shutdown?

Washington Policy Strategist Tom Block has been writing about the possibility of a federal government shutdown ever since Kevin McCarthy won the role of Speaker of the House in January, and now the shutdown deadline is upon us. 

Block collaborated with Ken Xuan and with Fundstrat Research Associate Alexandra Sinsheimer to look at the possible effects the shutdown might have on the market. The results are summarized in our Chart of the Week:

Of the 20 government shutdowns since 1960, the average shutdown lasted nine days, and markets on average were flat during those shutdowns. One month afterwards, markets on average were actually higher by 1.2%. The 1M median performance was +1.3%.

But there was one interesting implication. The Fed has long asserted that its policy decisions would be “data dependent.” We contacted the Bureau of Labor Statistics to find out how a shutdown would affect their operations, and we were told in summary that during a shutdown, the BLS suspends data collection, processing, and dissemination. Once funding is restored, the BLS would resume normal operations and notify the public of changes to the economic releases.

Would it make sense for the Fed to make a policy decision with incomplete data? If it was sufficiently long, a government shutdown might automatically put the Fed on a “structural pause.”

Elsewhere 

Evergrande shares were suspended from trading in Hong Kong even as Chinese authorities placed its chairman, Hui Ka Yan under official police surveillance (a form of home detention) and its Hengda Real Estate unit defaulted on a CNY 4 billion (USD $548.3 million) payment. Evergrande disclosed that authorities had told the embattled property developer that Hui is suspected of unspecified crimes. The week’s developments further weighed on fears for China’s troubled real-estate sector.

Another strike deadline looms, as 75,000 health care workers in five states (along with Washington, DC) have voted to authorize a strike if an agreement is not reached with their employer, Kaiser Permanente, by midnight of September 30 (Pacific time). The strike, scheduled for October 4-7, would be the largest healthcare strike in US history. Members of Service Employees International Union-United Healthcare Workers West union, which covers nursing staff, EMTs, and respiratory care practitioners, are demanding across-the-board raises, better retiree medical benefits, and increased efforts by Kaiser Permanente to attract more workers to alleviate the labor shortage.

Global trade volume fell by 3.2% YoY in July, the fastest rate of decline since August 2020, according to the World Trade Monitor.

UPS announced that it plans to hire 100,000 temporary workers to help during the holiday-season rush this winter, roughly the same as it did in 2022.

The FTC and 17 state attorneys general sued Amazon over antitrust allegations, asserting that the online retailer illegally uses pricing power and its own warehouse/fulfillment centers to deter competition. It was the latest volley by the FTC against Tech giants – the regulator also has an antitrust case against Google.  

Germany’s inflation rate fell to 4.5% YoY in September, down from 6.1% in August and the lowest since Russia invaded Ukraine. 

And finally: Netflix is formally ending the DVD-by-mail service that launched the company. The last five iconic red envelopes were mailed on Friday, and the five remaining disc distribution centers – in California, Texas, Georgia, and New Jersey, will be shuttered. (Recipients of the final DVDs mailed out will be allowed to keep them.)

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