Interest rates. Interest rates drove the markets in August. At the Jackson Hole central banking conference, Chairman Powell shocked markets with a speech committing the Fed to continued rate increases until inflation is under control—even if that leads to economic weakness. Markets had assumed that the Fed would pause increases in the event of a recession, but that perception changed after the speech, driving longer-term rates significantly higher.
Market pressure. In August, the U.S. Treasury 10-year yield reversed a July decline, rising from 2.6 percent at the start of the month to 3.15 percent at the end. Higher rates typically mean lower stock valuations, and this was a significant driver for the weak performance last month. The rise in rates has continued in early September, so there could be more pressure on the markets moving forward.
Slowdowns in growth. Higher rates have also started to weigh on growth. While some metrics remained strong last month, signs of a slowdown were apparent. Employment growth, although still healthy, was down from prior months. Business and consumer spending were also down, while the housing market has slowed dramatically.
Earnings. While recession worries moved away from headlines, fears about earnings remained. A slower economy typically leads to a slowdown in earnings, and analyst estimates of future earnings continued to decline in August. Investors remain cautious about the outcome, and that will likely weigh on markets going into the third-quarter earnings season.
Economic improvements. There were several positive trends in August—consumer confidence stabilized, and more people moved back into the labor market. Additionally, gas prices continued to decline, and inflation started to move down. So, while there are headwinds, they should continue to moderate in September and are supported by the substantial economic momentum.
International updates. Looking ahead to September, the economic effects in Europe appear to be stabilizing, while supply chains around China are also improving. Overall, the economic risks of the major international issues will likely continue to fade. We may see more turbulence, as the risks out there are real. As Russia’s position in Ukraine deteriorates, it might widen the war. Covid-19 could surge again, here or abroad. And when and if those things happen, we will see more market volatility.
As always, the headlines will drive short-term market performance. And, in the short term, the damage may continue.
Potential growth. Much of the damage from turbulence may have already been done, and September should indicate whether growth will continue. If job growth remains strong, with worries starting to moderate, we could see valuations stabilize and possibly improve. We may even see some appreciation, as fears about earnings growth lessen.
Looking back at August, we reversed the rebound of July, which proved to be premature. But, as we move into September, many of the fears that drove the renewed pullback are moderating.
August’s pullback reflected the real risks going forward, particularly for interest rates. And while those risks remain, most of them are likely incorporated into markets; as we move forward, the further effect should be limited. August was a bad month. But, unless we see fundamentals continue to deteriorate—and that’s not what we are seeing—September may be better.