The S&P 500 fell -0.74% this week with Friday's close at 4,288.05. The index has now decreased four weeks in a row for the first time since the end of 2022.
In terms of weekly closing prices, the S&P 500's four-week losing streak has only shed -5.04%, but it does feel like -15.04%. The index recorded its monthly high for September on September 1 and then proceeded to decline 11 of the last 19 trading days, losing ~300 handles from peak to trough in the process. As the great Helene Meisler said, there's "nothing like price to change sentiment", and the pullback the last two months has brought about a refresh in fear.
Interestingly, we like to put perspective on this recent selloff to keep us from feeling like the sky is falling, but we were looking for a "refresh in fear" in early August. So, it's not as if this pullback is all that unexpected. There is certainly a bit of hindsight bias here, but in our Update from August 6 we wrote:
"We continue to think the picture for the S&P 500 is mostly unfavorable over the near term, as we discussed last week. Our skepticism will clear when there's a refresh in fear, or a healthy pullback for the S&P 500. From a technical perspective, prices don't move linearly forever."
Well, bearishness has definitely ascended (click here) and the CNN Fear and Greed Index sits in the "fear" zone (click here). Objectively, there has now been a "refresh in fear", and now that we've recorded the healthy pullback we were asking for two months ago it's hard for us not to be optimistic about the S&P 500's prospects for the months ahead.
The index's daily Relative Strength Index over the last 14 days (RSI14) sits at 34.02, so we're almost "oversold", and there is a confluence of support at and around current price levels. Further, in last week's Update we wrote that we'd title this week's Update "Bend, but don't break!", and that's close to what the S&P 500 did this week.
Looking ahead, we now believe the picture is favorable for the S&P 500 over the near term.
Now, there is nothing stopping the S&P 500 from trading down into the ~4,100s as it potentially tests its 200-day simple moving average (red line on the chart above). We're not saying the index is absolutely off to the races from Monday's open. What we are saying is that we believe the index will retest July's high at the ~4,600 level at some point in the fourth quarter and we don't believe the index will trade much lower than the high 4,100s or the low 4,200s, assuming the bottom didn't land on last Wednesday. That's ~100 handles of downside for ~300 handles of upside, and that's a favorable risk/reward relationship!
A few months back we wrote that the word of the year to describe the price action for the S&P 500 would be "resilient". So we find optimism in the continued resilience the S&P 500 is showing. Think about the utter barrage of bad news the S&P 500 has had to deal with and compare it to just how mild the price decline has been thus far. Two months ago, when the S&P 500 sat around the ~4,600 level, the yield on a 10-year Treasury bond was around 4%, the U.S. Dollar Index sat at ~102, and the probability of the federal funds rate (FFR) sitting between 5.25-5.50% at the June 12, 2024 meeting sat around 10%.
Consider the picture now: The yield on a 10-year Treasury bond sits at 4.57%, the U.S. Dollar Index sits at 105.82 and has increased 11 weeks in a row, and the odds of the FFR sitting between 5.25%-5.50% at next June's Fed meeting sit at almost 40%. The "higher for longer" and "job's not done" mantra regarding inflation has dominated the landscape and yet the S&P 500 is only off ~5% from its year-to-date high weekly close in 2023. And that's after a more than ~700 handle and near ~20% move higher over the prior four months (i.e., the linear advance from March's low to July's high).
If you told us two months ago that all of the above would happen and asked us to guess where the S&P 500 sits, we'd have guessed below the 4,000 marker.
We recognize we run the risk of writing all of the above right in advance of the S&P 500 trading below the 4,000 marker, so a degree of fragility does still exist even in the face of "resilient" price action.
That said, it's not what we believe is next. We'd bet the S&P 500 is close to a lasting bottom here in the month of October.
Where there has been anything but resilience is the price action across long-term Treasury bonds as measured by the iShares 20+ Year Treasury Bond ETF (TLT). TLT has declined five weeks in a row, and nine of the last ten overall. TLT has lost -12.32% the last ten weeks and just fell -7.95% in September, its sixth worst monthly decline since inception. This is part of what shapes our optimism as to what lies ahead for the S&P 500.
Bond yields (i.e., interest rates) are a derivative of the price of a bond, so falling long-term Treasury bonds are lifting long-term interest rates (UST30Y) and this has obviously been a headwind for the S&P 500 the last 10 weeks. UST30Y closed Friday at 4.73%, its highest weekly close since 2011. Again, it's fairly surprising that there hasn't been more damage to the S&P 500 with UST30Y knocking on the door of 5% and in advance of a supposed economic contraction.
Economic data was once again mixed this week. Durable goods kicked off the week and they were an upside beat (click here). Pending home sales were a disaster (click here). Revised GDP came in right as expected (click here) and PCE came in cooler than expected (click here).
Ultimately, we do believe what the Fed has already done is enough to restore price stability, and that too shapes our optimism over the remainder of 2023.
In other words, we think the incoming data over the remainder of the year will continue to show that the federal funds rate is adequately "restrictive" to ensure continued price stability and fuel the "Fed pause". If the market agrees, it should take off to the upside here in October.
As for the week ahead, we'd like to see the S&P 500 come out of the gates strong and find its first positive week since August. There's perhaps a bit of a relief rally in the cards given the news out of our wonderful government (sarcasm, click here). Many were speculating on Friday that we were on pace for the longest government shutdown in our nation's history...so much for that.
S&P 500 Primary Trend - Up
The S&P 500 put the month of September in the books this week, declining -4.87%. This marks the fourth consecutive September to see the S&P 500 lose -4% or more.
September's decline marks a two-month losing streak, after the S&P 500 had recorded a five-month winning streak the preceding five months, and that's not all that common. The only other times where the S&P 500 followed a five-month winning streak with a two-month losing streak are:
October 2020
September 2016
April 2004
Ironically, the S&P 500 was then off to the races in each of those three prior instances after the two-month losing streak. This is because "corrections" are temporary and only interrupt primary uptrends. Long-term investors can best manage them by sitting on their hands. At the moment, that's what we believe is the best course of action for long-term investors - to be tolerable to the S&P 500's volatility in exchange for capturing the index's returns over the remainder of 2023. And if history is any guide here, we have a strong fourth quarter in front of us.
The table below lists all calendar years that met the following criteria: the S&P 500's monthly return was negative in both August and September, and the S&P 500's year-to-date return through September's monthly close was positive.
Our technical work continues to label the primary trend as up, or "bullish".
Broadly speaking, we believe most long-term investors are best served with an equity overweight across their portfolios' asset allocation and relying mostly on passive investing methodologies. It isn't until the primary trend can be labeled as down, or "bearish", where long-term investors should consider drastic portfolio rebalancing in order to be safe rather than sorry.
A -5% pullback after roaring to the upside for most of the year certainly isn't enough selling pressure for long-term investors to be overly concerned about. We reserve the right to change our mind in the event material selling pressure actually does emerge! Again, we don't think that is what's next.
Happy Sunday!
Steve & Rick