The road ahead
E*TRADE Capital Management
A hot summer rally was doused with cold water late last month as the US stock market experienced its biggest pullback in more than two months.
And although the market had begun retreating well before Jerome Powell’s speech last week at the Jackson Hole Economic Symposium, the Fed Chairman’s brief comments let the markets know—despite recent downticks in some measures of inflation—the central bank’s rate-hiking work isn’t close to being finished.
The Fed’s most recent message translates into 'higher interest rates for longer,' a reality that may continue to pressure the stock market.
The message: The Fed thinks it will take more time than many people expect to bring inflation down to acceptable levels. That translates into higher interest rates for longer—something Chairman Powell acknowledged could bring “pain” to households and the labor market.1
It may have been something of a reality check for the stock market, which halfway through August appeared to be ignoring any and all clouds on the horizon as it extended its rally off June’s lows. But before considering what may be in store for the next several weeks, let’s take a look at what the markets did last month.
Stocks retreated in the second half of August, with all major indexes losing ground for the month. The Nasdaq Composite fell the most, as tech stocks—which are more susceptible to rising interest rates—sold off sharply toward the end of the month:
The energy sector was the strongest corner of the S&P 500 in August—somewhat surprising, since crude oil prices ended the month roughly 9% lower. The tech sector took the biggest step back, but health care and real estate weren’t too far behind:
On the global stage, emerging markets outperformed developed markets—Latin American stocks bounced back from a weak July, and emerging European and Middle East equities also gained. The MSCI Emerging Markets Index rallied 0.4% while the MSCI EAFE Index of developed markets fell 4.7%, with European stocks (excluding the UK) one of the more significant underperformers:
Interest rates resumed their climb in August, and the yield curve remained inverted. (When long-term rates are lower than short-term rates, it can signal decreased confidence in the longer-term economic picture.) The benchmark 10-year T-note yield closed August at 3.13%, up from 2.64% at the end of July, but—for the second month in a row—it was below the 6-month, 1-year, 2-year, and 5-year yields:
With the markets about to enter the historically volatile September–October portion of the calendar, investors may want to keep the following themes in mind:
- The Fed isn’t finished. Last week Jerome Powell made clear the Fed wasn’t keen to back off rate hikes (or pivot to cuts in 2023), even though some of the major inflation gauges showed prices had moderated a bit from June to July. As noted, that suggests higher interest rates for longer. It may take several months of declining inflation for the Fed to feel comfortable about downshifting.
- Rising rates could weigh on tech and growth stocks. With the Fed drawing its line in the sand, tech and growth stocks—which many investors bid up during the summer rally—could face renewed pressure. Higher rates make it more expensive for these companies to borrow the money they need to maintain or expand their operations.
- US in a better position? The US market may still have an edge relative to international markets. A growing number of analysts appear to think Europe is more likely to experience a recession (or enter one sooner) than the US,2 and China’s economy has slowed amid COVID lockdowns and a housing downturn. Also, as noted here last month, international markets continue to be challenged by the strong US dollar, which ended last month near its highest levels since September 2002.
While the market’s recent downturn gives a little more credence to the idea, supported by Morgan Stanley Wealth Management, that the rally off the June lows was best thought of as a bear-market bounce, it doesn’t call for investors to rethink their long-term plan. On the contrary, it’s a reminder that a diversified portfolio coupled with disciplined rebalancing remains one of the best defenses against uncertainty and volatility.
Thanks for reading, and we’ll talk to you again next month.
Head of Portfolio Construction for Morgan Stanley Portfolio Solutions
Mike Loewengart is Head of Portfolio Construction for Morgan Stanley Portfolio Solutions and a Managing Director in the Morgan Stanley Wealth Management Global Investment Office. Mike is responsible for the asset allocation and investment vehicle selections used in E*TRADE’s advisory platforms. Prior to joining E*TRADE in 2007, Mike was the Director of Investment Management for a large multinational asset management company, where he oversaw corporate pension plan assets. Early in his career, Mike was a research analyst focusing on investment manager due diligence for the consulting divisions of several high-profile investment firms. Mike holds series 7, 24, and 66 designations, as well as the Chartered Alternative Investment Analyst (CAIA) designation. He is a graduate of Middlebury College with a degree in economics.
Executive Director, Morgan Stanley WM Global Investment Office
Andrew Cohen is an Executive Director in the Morgan Stanley Wealth Management Global Investment Office and an investment strategist for ETCM LLC. Prior to joining E*TRADE, he was the Director of Investments and Operations for a large Registered Investment Advisor, where his responsibilities included investment manager research, asset allocation, and portfolio construction. Previously, he was a Senior Research Analyst and Team Leader for a leading wealth management platform. He is a Chartered Financial Analyst (CFA®) charterholder and a member of the CFA Institute and CFA Society New York. He is a graduate of Virginia Tech with a Bachelor of Science (B.S.) in finance.
1 CNBC.com. Powell warns of ‘some pain’ ahead as the Fed fights to bring down inflation. 8/26/22.
2 Bloomberg.com. Economists Say a Euro-Zone Recession Is Now More Likely Than Not. 8/14/22.
3 MorganStanley.com. The Increasing Risk to Earnings. 8/29/22.
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