It’s hard to believe that we only have one more trading day to go before we close the books on the third quarter.  While we are ending with market animal spirits running high, this was not an easy quarter for investors. Views regarding the state of the economy seemed to change week to week, as did predictions for interest rates. Considering where sentiment stood at the end of June, the final results will be seen as much better than expected. The question is whether we can continue this optimism in the final months of the year?

You will recall that the second quarter wasn’t a picnic either in terms of the gyrations in both bonds and equities, especially if we look at the Dow, Russell 2000 or TSX. The sharp sell-off in April was followed by a brief recovery in the first half of May, before another setback and then partial rebound into the end of the quarter. Both indices started the third quarter well back of their peaks seen in May. The experience was much better for the S&P500 and NASDAQ, where both ended the second quarter near record highs, driven by renewed euphoria among the so-called “mag 7” stocks.

As you can see from the chart below, the Solactive Mag 7 index not only recovered from close to a 10% correction in April but went on to finish June with close to a 15% gain for the quarter overall. The third quarter presented this group with a much rougher ride. From July 10th to the first week of August, the index fell by more than 18%. Following a brief lift in August, it then slipped 8% into September. The tone today has once again turned positive after the index broke back above its August high, but it still remains below its peak in July.

The irony as we head into October is that the broader markets have moved on to set new record highs, reinforcing the call that we and other analysts have made that market leadership would broaden out in response to the pivot by most global central banks towards less restrictive policy. The stats for the quarter bear this out.  At the time of writing, the TSX was up close to 10% for the third quarter overall, followed by close to an 8% rise in the Dow and Russell 2000. The S&P is lagging behind with a gain so far of 5% and the Mag 7 index is up about the same. The clear underperformer has been the NASDAQ, with a move of +only 2% since the end of June.

But where the relative strength in the tech sector at the end of June turned out not to be a good indicator of what the next quarter will deliver, the same may hold true today in terms of the relative drag by this group. Talk in recent weeks that the artificial intelligence (AI) trade could fade as businesses curtail investment ahead of a potential recession, Micron comes out this week with an earnings report that shot the lights out.  Its quarterly revenue growth was the best in ten years and its forecast for the current quarter exceeded street estimates. It still sees strong demand for its chips, which are used in Nvidia’s processors, suggesting that the sunken feeling towards AI was premature.

A positive shift in sentiment is also showing up on the economic front.  True, this week’s report on consumer feelings for the month of September wasn’t exactly inspiring. As the above chart shows, the Consumer Conference Board consumer confidence index fell back to below 100.  The decline was the largest in three years and was attributed to concerns over employment. What is interesting is that the present situation component of the index showed the largest pullback, while the expectations index slipped by a more modest amount and remained above 80 – a level that is generally viewed as breakeven for recession. The other cutoff for the September survey was the 17th – a day before the FOMC announced a half-percent rate cut.

While consumers did indicate less confidence in their employment prospects, both present and down the road, recent indicators suggest that the labour market isn’t exactly falling off a cliff.  In the above chart, I show initial jobless claims for the U.S. There had been a steady rise in claims from the start of the year through to July, but the last several weeks have seen unemployment applications decline to below 220,000.  It’s clear the labour market isn’t as red hot as it was in 2022, but these levels are not indicative of a recession.

Next week, we will get the September employment figures for the U.S. and after the last couple of months, the bar has been set fairly low in terms of expectations for growth in non-farm payrolls and the unemployment rate, though the claims figures we are seeing suggests we might get a better-than-expected print. If so, that could further alleviate recessionary fears among equity participants, while combining with the Fed’s first rate cut to improve consumer sentiment and the spending outlook for the fourth quarter.

Note, that may also affect how we start the next quarter with respect to the fixed income market. By the end of June, the U.S. bond market was still trying to scrape back from the losses inflicted during the first quarter. Evidence of continued declines in inflation, weaker growth and expectations of a Fed pivot fueled an advance in bonds that led to a full recovery of the first quarter’s pullback. The chart above shows the S&P US Aggregate Bond index, and you can see that we have also pushed above the high-water mark from late last year. By the middle of this month, the index had already returned to levels not seen since August 2022.

The other week, I commented on how much Fed easing had been priced into the curve and that a lot of the low-hanging fruit had been picked in terms of post-2022 bond reversal. That doesn’t mean that there is no more fruit to be had, but if we saw more signs of economic resilience than recession, Fed expectations could be pared back. That could flatten the trajectory for bonds in the fourth quarter.

While we can celebrate a solid Q3 for both bonds and equities, there are still a few things that could cause more turbulence in Q4, starting with an event in early November.

On behalf of the Pyle Wealth Advisory team, have a great weekend.   

Andrew Pyle