Key Takeaways from August's Market Volatility
Photo Credit: Jonathan Simcoe, Unsplash
Weekly Market Recap for September 6th
This week, the stock market experienced heightened share-price volatility. Investors are grappling with numerous uncertainties, including the direction of Federal Reserve rate policies, persistent inflation, fluctuating employment figures, corporate earnings, and the impending presidential election results. Additionally, concerns extend internationally with ongoing military conflicts in the Red Sea, the Middle East, and Eastern Europe.
The U.S. Bureau of Labor Statistics (BLS) has released the employment figures for August. The economy saw an addition of 142,000 jobs, falling short of the anticipated 161,000, and marking a significant revision down from July’s initial report of 114,000 to 89,000. Despite this, hiring remains robust. The unemployment rate was reported at 4.2%, aligning with economic forecasts and showing a slight improvement from the 4.3% recorded in the previous month.
US Market Cycle Indicator
Source: MarketDesk
Equity Market Recap
The big story during August was market volatility in the first week. A mix of factors contributed to the selloff, including the unwinding of the Japanese yen carry trade, broader deleveraging, and economic growth concerns following a rise in unemployment.
However, financial markets quickly stabilized and traded higher as investors bought the dip. Despite the volatility, the S&P 500 ended the month with a +2.3% gain, trading less than -1% below its all-time high from mid-July. Our U.S. Technical Indicator (USTI) tracked the rapid selloff and recovery. Defensive factors and sectors like Minimum Volatility, Consumer Staples, Real Estate, and Health Care outperformed, while riskier factors like Small Caps and High Beta underperformed. One notable theme was the continued rotation underneath the surface. The S&P 500 equal weight index outperformed the S&P 500 market cap for the second month in a row. The Nasdaq 100 Index, which includes the artificial intelligence companies that drove the stock market higher in early 2024, underperformed the broader market for the second consecutive month. Most of the Small Caps' underperformance occurred during the early-month volatility, with the Small size factor keeping pace with the S&P 500 as the month went on.
We expect this rotation to continue as mega-caps' dominance eases, and we believe there is significant opportunity within the broader index.
US Market Technical Indicator
Source: MarketDesk
Investor Positioning and Technicals
Indicators suggest the market can still trade higher through year-end. The US Breadth Indicator (USBI) currently reads 69, signaling above-average returns over the next 1, 2, 3, and 6 months. The US Investor Sentiment Indicator (USSI) reads 74, signaling above-average returns over the next 3- and 6-month periods. August equity market flows were an indication of positive investor sentiment. Although inflows slowed, they remained positive as investors bought the dip after the early-month selloff.
Asset manager futures positioning initially declined as the group deleveraged but increased later in the month as they re-levered. Both USBI and USSI suggest slightly above-average returns and win rates in the intermediate term (3-6 months). Heading into year-end, we classify the market as vulnerable to a sudden shift in sentiment or a negative catalyst but not necessarily destined for a selloff. There is no immediate need to turn risk off, but also no need to run a max risk on the portfolio. Looking ahead to 2025, USBI and USSI show that a lot is already priced into equity markets. In particular, USSI and fully invested asset managers signal the potential for below-average returns.
US Market Breath Indicator (USBI)
Source: MarketDesk
US Market Sentiment Indicator (USSI)
Source: MarketDesk
Corporate Earnings
Earnings estimates remain strong, with most of the forecasted growth tied to expectations for margin expansion. Analysts expect earnings growth to outpace sales growth across most factors and sectors over the next 12 months. Key macro drivers suggest the broader macro backdrop supports earnings growth, aligning with our S&P 500 Earnings Indicator (USEPS). Although USEPS remains below the +14% consensus estimate, it continues to rise. One theme we are monitoring is the potential for a broader corporate earnings recovery, particularly among companies outside of the Magnificent 7 group. Earnings for the S&P 500 equal weight contracted by -0.5% over the past 12 months but are forecast to grow by +10.7% over the next 12 months, driven by profit margin expansion. This potential for narrowing earnings growth is another reason we see a significant opportunity beyond mega-cap stocks, which have more reasonable valuations and could become more attractive if earnings growth turns positive.
S&P 500 Earnings Indicator
Source: MarketDesk
Looking Ahead to September
The market appears set to continue its upward trajectory. Our primary concern isn't the economy itself, but rather the overly optimistic sentiment among investors. Current consensus earnings forecasts seem overly ambitious, and there is an expectation among investors for a significant reduction in earnings, more typical of a recession than a merely slowing economy. While volatility isn't expected to trigger a systemic liquidity crisis, it may still unsettle investors. With the market currently favoring risk and benefiting from positive second-half seasonality, we anticipate that investors will continue to buy on dips. For the time being, we are happy to go along with the market's momentum.
Important Disclosures
This material is provided for general and educational purposes only and is not investment advice. Your investments should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities, or investment-related service or product, including any investment product or service described in these materials.
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