Central Bankers, Currencies, And Calendar Unkind
September 2022
September has historically been a challenging month for equity investors. The S&P 500 has generated an average monthly loss of 1% during the month since 1928 and September also has the distinction of being the only calendar month in which the S&P 500 has closed with a loss more times than it has ended with a gain over that time frame. While the S&P 500’s bounce from mid-June into mid-August was welcome, there was a give back of gains into month-end and this month could be poised to live up to its historical billing. September has proven to be a pitfall-ridden spot in the calendar and may prove to be so again due to tightening monetary policy, a strong U.S. dollar, and negative seasonality effects magnified by equity weakness in late August.
The S&P 500 traded at 18.2 times expected 2022 earnings and 16.8 times projected 2023 earnings as September began after rallying from mid-June into the Fed’s Jackson Hole symposium in late August. Equity valuations now appear ‘full’ given our expectation that the Federal Open Market Committee (FOMC) will stay on course and tighten monetary policy into a weakening U.S. economy as it attempts to decrease demand to match limited supply. Global economic growth should slow due to tighter monetary policy and geopolitical unrest, and we expect U.S. dollar strength to persist, all headwinds for U.S. multinationals. Companies in the S&P 500 may be challenged by a ‘stronger for longer’ U.S. dollar, but our bias toward quality, profitable, free cash flow generating companies returning capital to shareholders leads us back to that index as a port in the storm. Domestic small and mid-cap (SMid) stocks could fare relatively well as beneficiaries of a stronger dollar and have minimal exposure to weaker economies abroad. However, higher interest rates and widening credit spreads will act as hurdles, leaving us with a neutral allocation to SMid as a result.
Commodity prices rolled over in mid-June, leading to optimism surrounding the path forward for equities as, in theory, the FOMC would have the cover to make a dovish pivot in the back-half of ‘22. FOMC Chair Jerome Powell dashed hopes of such a policy shift at Jackson Hole in late August, spurring a sell-off in equities. However, despite rising recession fears, West Texas Intermediate (WTI) crude oil and natural gas prices held up as supply fears dominated. Recession probabilities rising acts as a headwind for commodity prices due to lower projected demand but will be offset to some degree by geopolitical uncertainty. OPEC announced a symbolic 100k barrel per day supply ‘cut’ in early September, showing a commitment to support prices, while civil unrest in Iraq/Libya and talks between the U.S. and Iran stalling could lead to ongoing supply worries and price volatility. Fears of commodity shortages should persist alongside geopolitical uncertainty, a backdrop that leads us to a constructive outlook on real assets and companies levered to sustained higher prices for energy and agricultural commodities.
Higher energy and electricity prices are weighing on the euro area and are likely to lead to economic pain throughout the balance of this year and well into 2023 as businesses close and unemployment rises. These issues could be compounded by the European Central bank (ECB) entertaining the idea of a 75-basis point hike to key deposit rates later this month as Eurozone inflation data remains worrisome. As the energy/electricity situation remains tenuous, government support/bailouts appear to be a likely path forward, which is an expensive short-term solution likely to generate additional weakness in the euro. The European Union (EU) could still balk at following through on harsh sanctions against Russia to get the natural gas spigot turned back on, avoiding the worst-case scenario, but Russia would likely only do so with ‘expensive’ stipulations. In-fighting and political dysfunction are the norm in Europe, and an underweight to international - developed market stocks is warranted as a rough winter likely lies ahead for Europe’s economy and Eurozone equities.
A skew toward the U.S. within equity portfolios will likely be rewarded over coming quarters as developed and emerging markets abroad face even more substantial headwinds, with few easy fixes. Europe’s struggles have been well documented, but Japan is dealing with yields on Japanese Government Bonds sitting at uncomfortably high levels for the Bank of Japan (BoJ), forcing them to print yen to buy bonds as they implement yield curve control. Rolling lockdowns continue in China, pressuring global supply chains and pushing prices for goods higher, weighing on consumer confidence and contributing to a sense of global economic angst. The wall of worry global equities are scaling is likely to grow taller leading up to mid-term elections in the U.S. and a defensive posture remains warranted.
Source: Bloomberg, Factset
