No Relief: Early Rally Seen Unconvincing as Stocks on Pace for Worst Week Since March, D.C. Shutdown Fears Grow

(Friday market open) Bearish sentiment already prowled Wall Street thanks to skyrocketing Treasury yields, a hawkish Federal Reserve, 10-month highs in crude oil, a firm dollar, and the autoworkers’ strike, so growing fear of a government shutdown is arguably the last thing investors need.

Yet concerns mounted about exactly that as the week neared a close with no real signs of progress on Capitol Hill ahead of an end-of-month budget deadline. Shutdown worries add another blow to major indexes already reeling from the Fed’s hawkish rate projections.

Previous government shutdowns haven’t hurt Wall Street severely, but a prolonged one could potentially bite into Q4 economic growth. So could the United Auto Workers (UAW) strike, which has potential side effects on auto industry suppliers. For instance, U.S. Steel (X) plans to idle an Illinois blast furnace and temporarily lay off of hundreds of employees, citing the strike, according to the Chicago Tribune.

Friday begins with the S&P 500® Index (SPX) and the tech-heavy Nasdaq-100 (NDX) down 2.7% and 3.3% this week, respectively, on track for their worst weekly performance since March. It would also be their third negative week in a row. The broader market is down 4% month to date, back to levels last seen in mid-June. Stocks rose in premarket trading on little fresh news.

“The overnight rally is unconvincing for now,” says Kevin Gordon, senior investment strategist at Schwab. “It seems like a weak attempt to try to regain ground after yesterday. The path of least resistance is down as long as market breadth continues to deteriorate.”

Only 20% of S&P 500 stocks now trade above their respective 50-day moving averages, the lowest since March, he adds. “The rub with this sell-off since the end of July is it’s been broad-based.”

Morning rush

• The 10-year Treasury note yield (TNX) was little changed at 4.48%.
• The U.S. Dollar Index ($DXY) edged up to 105.56, just below 2023 highs.
• Cboe Volatility Index® (VIX) futures fell to 17.01 but are up sharply for the week.
• WTI Crude Oil (/CL) edged higher to $90.68 per barrel as Russia temporarily banned exports of gasoline and diesel.

Shares of real estate, consumer discretionary, and financial companies were among the market’s poorest-performing sectors Thursday, with the KBW Regional Banking Index (KRX) sinking to an 11-week low. Nearly 16-year highs in Treasury yields likely played the villain.

Just in
Overnight, the Bank of Japan (BoJ) left rates unchanged at –0.1% and kept its interest rate targets unchanged, as well. In its statement, the BoJ cited “extremely high uncertainties surrounding economies and financial markets at home and abroad,” and vowed to be patient but nimble. The statement and decision appeared to reflect a desire not to rock the boat; in July, the BoJ sent shockwaves through world markets by widening its yield-curve control range. The BoJ still has its target rate in negative territory, but about half of economists polled by Bloomberg expect a rate hike in the first half of 2024, Barron’s reports.

Back home, there’s no sign of progress in negotiations with the striking United Auto Workers (UAW). The UAW set a deadline for today at noon ET to expand strikes, and media reports say major automakers aren’t budging. Depending on its length and severity, the strike could impact Q4 economic growth.

Eye on the Fed
As of this morning, the probability that the Federal Open Market Committee (FOMC) will raise rates at its November meeting is 27%, according to the CME FedWatch Tool. There’s around a 42% probability priced in that rates could be a quarter-point higher coming out of the December meeting.

The market might be returning to a “bad news is good news” mode like the one seen a year ago. The Fed apparently doesn’t feel it’s killed off inflation and remains ready to hike at least once more this year, so investors may cheer data that bodes poorly for the economy.

The Fed’s prime goal now is a return to price stability, Chairman Jerome Powell said on Wednesday. One way to read this is that the Fed will do what it takes to ease inflation, even at the expense of jobs. On a positive note, Powell says inflation expectations remain “anchored” and the Fed plans to move “carefully” on rate decisions—which it can do because it moved so dramatically late last year. Borrowing costs could stay high regardless.

“It’s worth noting that even if the Fed is done with its rate hikes, monetary policy is still ‘tight,’” says Kathy Jones, Schwab’s chief fixed income strategist. “Leaving short-term nominal rates at current levels as inflation falls will send real yields—adjusted for inflation—higher. In addition, the Fed is still in the process of reducing its balance sheet by allowing bonds it holds to mature without replacement. The Fed has signaled that process is likely to continue even when it shifts to lowering the fed funds rate. Watching to see how all of these policy measures play out will likely keep the Fed on hold until Q2 of next year.”

What to watch
Week ahead: Monday’s schedule is quiet as Q3’s final week begins. Things pick up from there, with investors getting a look on Tuesday at September Consumer Confidence and August New Home Sales. August Durable Goods follow on Wednesday, and Thursday brings the final estimate for Q2 Gross Domestic Product (GDP) after a downward revision last month to 2.1% from 2.4%. The week will close next Friday with Personal Consumption Expenditure (PCE) prices, the inflation metric watched most closely by the Fed.

The last week of a quarter sometimes features more volatility as fund managers engage in “window dressing,” dumping losers and adding winners before mailing quarterly results to their clients.

The earnings schedule is light next week, but the companies that do report could pack a punch, including semiconductor giant Micron (MU) and athletic firm Nike (NKE). Earnings season starts in earnest by mid-October, but seeing big names step to the plate is like hearing the first robin of spring.

Speaking of earnings, look today for research firm FactSet’s update on Q3 S&P 500 earnings growth expectations. The last estimate fell to 0.2% from 0.5%, and we’ll see whether analysts start pulling back after the Fed’s hawkish outlook. However, Q3 is basically over, so the impact, if any, is likely on longer-term earnings estimates.

Washington will occupy center stage as investors assess chances of an October 1 government shutdown. Wall Street could be ultra-sensitive to headlines next week.

Talking technicals: The S&P 500 Index (SPX) gapped lower early Thursday and closed below the 100-day moving average (around 4,375) for the first time since late March. The SPX is now down about 6% from July’s 16-month intraday high. The SPX closed Thursday just below 4,335, the low from mid-June and mid-August. A serious break below that could confirm a “head-and-shoulders” top, a bearish chart formation that often signals further downside, says Nathan Peterson, director of derivatives analysis at the Schwab Center for Financial Research. Below 4,335, the next key support level is around 4,200, just above the 200-day moving average near 4,189.

Thinking cap
Ideas to mull as you trade or invest

5% ahead? The Fed’s hawkish tone lit a fire under the 10-year Treasury note yield, which now trades near 4.5%—more than 120 basis points above last spring’s lows. If the charts are correct, there may be steeper slopes to climb. The next major technical resistance area is near 4.575%. Unfortunately, this may simply be a rest stop, because there’s a range between 5.35% to 5.50% that technicians say is a major resistance area. The 10-year yield is correlated with the 30-year mortgage and other long-term lending rates, so any further climb could hurt demand for large items like cars, mortgages, and household goods bought on credit. It also could weigh on commercial real estate—with the impact extending to regional banks that typically provide loans in that market. This could help explain why financial stocks dove Thursday and spell more trouble ahead for the small-cap Russell 2000 (RUT) index, with its heavy exposure to financial stocks.

From “Abundant” to “Temperamental”: The recent rally in crude oil and interest rates serves as a reminder that a new economic era of more scarcity is upon us. “From the mid-1990s until the pandemic, the world enjoyed relatively cheap and abundant access to goods, energy, and labor,” says Schwab’s Kevin Gordon. “Those ships have sailed as we now have a much more volatile inflationary backdrop, worsening demographic trends, and geopolitical ruptures that are leading us back to a temperamental era.” The impact this might have on markets is a return to the pre-1990s trading environment characterized by a negative correlation between bond yields and stock prices, he adds.

Relief driver: Crude oil’s rally sets up American motorists for a frightful month at the gas pump. But futures prices indicate that by the holidays, drivers may receive a gift that keeps on giving well into 2024. Front-month WTI crude futures (/CL) recently hit 10-month highs above $93 per barrel. But futures prices for November delivery through summer 2024 trend progressively lower (a “backwardated” market, in futures-trader parlance), dropping under $81 by next August. The recent run-up in oil prices reflects OPEC production cuts and strength in the global economy. But the outlook for less-pricey oil next year reflects expectations the economy will slow, potentially into recession. The Energy Information Administration (EIA) forecasts gasoline to average $3.54 a gallon in Q1 2024, down from $3.75 in Q3 2023. Falling gas prices don’t just help motorists. It could be good news for slumping transport sector stocks.

Calendar

• Sept. 25: No major earnings or economic data.
• Sept. 26: September Consumer Confidence, August New Home Sales, and expected earnings from Costco (COST).
• Sept. 27: August Durable Goods and Durable Orders, and expected earnings from Micron (MU).
• Sept. 28: Third estimate of Q2 Gross Domestic Product (GDP), August Pending Home Sales, and expected earnings from CarMax (KMX) and Nike (NKE).
• Sept. 29: September Chicago PMI, August Personal Income and Personal Spending, August Personal Consumption Expenditures (PCE) prices.
• TD Ameritrade® commentary for educational purposes only. Member SIPC.