By Ellen Hazen, CFA®, Chief Market Strategist

September Takeaways:

• Inflation continued to ease with the Consumer Price Index increasing at 2.5%, down from 2.9% in the prior month
• The Federal Reserve (“Fed”) reduced interest rates. Mid-month, the Fed reduced its overnight interest rate by 0.5%, the first cut in over four years. Currently the market expects another 0.75% cut by yearend, in line with the Fed’s own Statement of Economic Projections
• Longer-term interest rates declined. The yield curve shifted down during September, with the maturities under a year seeing 0.4%-0.5% rate declines, while longer-term maturities saw yields decline more modestly, by 0.15%-0.3%. Both high-grade and high-yield credit spreads narrowed, reflecting investors’ increased confidence in corporate borrowers’ creditworthiness. Consequently, the Bloomberg Intermediate Government / Credit Index appreciated by over 1% during the month
• Growth equities outperformed Value equities. The Russell 1000 Growth Index appreciated by 2.8%, performing materially above the Russell 1000 Value Index, which appreciated by only 1.4%. Small-capitalization stocks struggled to keep up with their larger brethren, with the S&P SmallCap 600 Index appreciating by only 0.8%. The MSCI EAFE Index, which consists of international stocks, appreciated by only 1.0%
• The “Magnificent Seven” outperformed the broader S&P 500 Index. These seven stocks appreciated by over 6% during September, while the overall S&P500 Index appreciated by only 2%. We expect the equity market to broaden beyond these seven stocks, following broadening earnings growth
• China monetary stimulus and the promise of fiscal stimulus drove Chinese stock appreciation. Responding to Chinese economic growth softening, the Chinese government announced significant monetary stimulus, including reducing the amount that banks must hold in reserve from 10% to 9.5%, reducing the consumer mortgage borrowing rate by 0.5%, and reducing the central bank interest rate by 0.2%. Chinese shares rallied substantially, with the CSI 300 finishing the month up by over 21%
• Consumer delinquencies are slowly creeping up. Credit card and auto loan delinquencies have increased modestly from decade-low levels. If this weakening accelerates, it could be a negative signal for the health of the US consumer

What We Are Watching In October:

• US Corporate Earnings. US companies will start reporting third-quarter earnings in the second week of October. Currently estimates are modest, looking for 2.8% earnings growth in Q3 and 10% in Q4. The sectors with the fastest earnings growth are expected to be Technology, Communications, and Healthcare, while the slowest earnings growth is expected to be Energy and Materials
• Inflation – will it continue to ease? The Consumer Price Index (CPI) will be reported on October 11. We expect CPI to remain roughly at the same level as last month, at about 2.5%
• Jobs to be reported October 4. We expect the labor market to continue to cool, albeit modestly. Currently economists expect 150,000 new jobs to have been created in September, modestly above the 142,000 level seen in August
• East and Gulf Coast port worker strike. Members of the International Longshoremen’s Association (ILA) went on strike on October 1. If lengthy (greater than 2 weeks), this could prove inflationary and could negatively impact Q4 GDP. It would also likely negatively impact October new jobs, which will be reported in early November

The strong economy in 2024 has been one contributor to the rising equity market. Year-to-date, the large-capitalization S&P 500 Index is up about 22%, while the broader Russell 3000 Index is up about 21%. This has not happened in a straight line, however; there have been several noticeable declines this year, including a 5.7% decline in April, a 9.1% decline in July-August, and a 4.3% decline in September.

Given these periodic declines, investors could be forgiven for believing that volatility has been unusually high this year. In fact, as measured by the Chicago Board Options Exchange Volatility Index (VIX), median S&P 500 Index volatility in 2024 has been only 14.1%, below the 5-year average of 21% and the 10-year average of 17%.

We anticipate volatility may increase in the coming weeks as it often does in October. Moreover, currently elevated equity valuations, the US presidential election, and disquiet in the Middle East could contribute to yet another pullback in equity markets.

Some investors may rush to reduce equity exposure ahead of this setup. We advise differently. We believe investors are best positioned by staying in the race for the long term rather than trying to time the market. While people’s natural tendency is to reduce risk in the face of volatility, many studies show that is exactly the wrong action. Daniel Kahneman and Amos Tversky, largely considered the founders of behavioral economics, showed that people predictably behave irrationally with respect to finance, particularly to avoid losses. One example is selling after prices have already declined. You can see direct evidence of this in Dalbar’s annual Quantitative Analysis of Investor Behavior (QAIB). In the most recently published QAIB study, Dalbar found that over the past 30 years, the S&P 500 Index has returned an average of 10.2%, while the average equity fund investor has earned only 8.0%. The primary difference between these numbers is attributable to investors’ (poor) timing: equity investors too often bought high and sold low.

Why is it so hard to successfully time the market? One reason is that it’s harder to be smarter than everybody else; the markets typically incorporate all known information in something close to real time. More importantly, though, when attempting to market time, an investor needs to get two decisions correct: the right time to exit (which may be too early if stocks continue to rise), and the right time to get back into the market. Tales abound of investors who sold their equity holdings during the Covid-19 crisis, or during the trade wars, or during the Brexit crisis, or during the mortgage crisis, and have been invested in cash ever since, missing out on superior equity returns.

Economists famously say that there is no such thing as a free lunch, but there are a few investing principles that come close. One is that diversification – owning a variety of asset classes that are not completely correlated with one another – can provide better risk-adjusted returns than simply owning one asset class. Another is the value of compounding: if an investor leaves his/her money invested, returns will multiply as one year’s profits get added to the base on which an investor earns a return in subsequent years. We would argue that time diversification is another one. While returns measured over short time periods can be very high or low – especially in equities – if instead one measures returns over rolling 20-year, 10-year, or even 5-year windows, volatility materially decreases.

Our message: If volatility increases between now and yearend, remember that market timing is difficult – if not impossible. Few investors correctly identify both the optimal exit time and the optimal re-entry time. While volatility can be high when measured over a short time period, looking longer-term highlights that volatility that seems high now may very well fade into the rearview mirror.  Better to stay on your journey.

Disclosures