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Never underestimate the fickleness of Wall Street. The irrational exuberance that gripped Wall Street through the month of August courtesy of a developing bubble in everything AI (artificial intelligence) coupled with the hope of interest cuts in the 4^th quarter, has given up the ghost. Not withstanding the historical, generally negative, performance of markets in September, this month investors are finally succumbing to the notion that US interest rates will stay higher for longer. And the malaise is not the fault of Jay Powell at the Federal Reserve. He has been on point all year that they will not make policy switches until inflation is back to 2% levels.

His mandate of full employment, stable prices, and to some extent, a steady Greenback (US Dollar) requires a hawkish approach to interest rates. In our opinion, his job has been made more difficult due to the massive deficit spending programs undertaken by President Biden and the Democrats. If we are not mistaken, governments are supposed to reduce spending during economic booms and increase it when times get tough. Right now, their policies are akin to throwing gasoline on a bon fire.

In fairness, there are cracks developing in many sectors of the US economy. US Housing Starts plunged in August by 164,000 or 11%, the worst number since June 2020. “Leading Indicators” continues to post negative numbers and US Purchasing Managers Index is well below 50 signalling a possible recession on the horizon. Normally this might sway interest rate policy, but unfortunately, the US economy continues to add more jobs in the labor force giving the Fed, some wiggle room.

We also note the UAW is sticking to its gun of a 36% pay package based on a 40-hour work week but only on the job for 32 hours. Are we the only ones that scratching our heads on that one? Perhaps they are trying to take a page out of some politician’s playbook. Regardless, a big worry on the horizon is skyrocketing wage demands that either reduce corporate profitability or increased costs aka inflation on goods and services produced in the economy. To us it looks like a “heads we win/tails you lose” scenario and may push out any interest rate cuts.

So how do the factors above translate into market action? Year to date we have bifurcated markets. If you have been following the price action of the magnificent seven, formerly that FAANG, their outsized returns have helped push 33% gain in Information technology (thank you Nvidia, Microsoft and Apple) while consumer Discretionary (Amazon and Tesla) sector jumped 27%. Meanwhile, we have negative returns in Utilities, Healthcare, Real Estate, and financials.

In Canada the picture is even worse, with Utilities, Communication Services, Real Estate, Materials and Global Gold all posting negative year to date returns. Not too unsurprising given higher interest rates and a sluggish Chinese economy importing fewer raw materials. But there is also a bit of a silver lining, thanks to a dozen gold mining stocks imbedded in the “Materials Index” that have posted greater than 10% returns this year. Plus, as closet bulls, we are happy to see a dozen energy companies in the same boat.

Still these higher rates will likely continue to depress certain sectors of the stock market, leading to a rather anemic return for the Dow Industrials and the TSX. Plus, we note the potential for further repricing of high beta stocks trading at elevated prices. When you factor in the end of the third quarter next week, expect to see some window dressing (aka sell the dogs and buy the winners).

Lastly, we note the all important PCE (Personal Consumption Expenditure) index reports on Friday and with it being the preferred measure of inflation by the Federal Reserve, any surprises to the upside could pull markets lower during the first week of October. Factor in 200 odd companies reporting earnings including Costco, Nike and Micron (plus Blackberry and Aritzia in Canada) and it could be a bumpy ride. Cross your fingers.

Steve Bokor and the Ocean Wealth Team.

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