Rising interest rates and inflation fears sink stocks

October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February. – Mark Twain

In another volatile week of trading, the major stock averages succumbed to fears of rising inflation, higher bond yields and the prospect of Federal Reserve tapering sooner rather than later and closed lower. The technology-laden Nasdaq Composite Index suffered the worst losses as it shed over 3% while the S&P 500 Index dropped over 2%. September lived up to its reputation for being the worst performing month for stocks as the S&P 500 was down 4.8%, by far the worst month of the year for the stock market. The carnage began on Tuesday when the yield on the 10-year Treasury eclipsed 1.55% after beginning the month of September at 1.31%, causing technology and other growth stocks to plunge. Rising bond yields hurt growth stocks because they lower the relative value of future earnings and make these stocks look overvalued. Investors sold these growth stocks and rotated into so-called value stocks which are less expensive than their growth counterparts and should benefit from an improving economy. There were also concerns that rising inflation may be more permanent than originally thought. Federal Reserve Jerome Powell testified before Congress and said that inflation could persist longer than expected due to supply chain issues and economic reopening pressures. Wrangling in Washington over government funding, infrastructure spending and the debt ceiling also weighed on market sentiment, although by week’s end the Senate and the House of Representatives had passed a resolution to fund the federal government until December 3^rd. While this avoids a government shutdown for at least a couple of months, it does nothing to address the debt ceiling, which must be raised by October 18^th to avoid a U.S. government default. For this reason, stocks are likely to remain volatile and bond yields are likely to increase until this issue is resolved. October has a history of some major market sell-offs but the fourth quarter is generally a positive one for stocks. Over the last 30 years, the S&P 500 Index has gained an average of 4.8% during the fourth quarter.

Last Week

August durable goods orders were better than expected and have increased in 15 of the last 16 months while the ISM manufacturing index for September was slightly better than expected. The final reading of second quarter GDP was 6.7% compared to the previous estimate of 6.6% and pending home sales in August were well above expectations. On the negative side, September consumer confidence fell to a 7-month low as concerns mounted about the economy’s near-term prospects due to the rise in the number of positive cases of the Delta variant of Covid-19 and less optimism about the labor market. Weekly jobless claims were also higher than expected and totaled 362,000, an increase of 27,000 from the previous week.

For the week, the Dow Jones Industrial Average declined 1.4% to close at 34,326 while the S&P 500 Index lost 2.2% to close at 4,357. The Nasdaq Composite Index dropped 3.2% to close at 14,566.

This Week

There is little in the way of economic data on the calendar this week but the September employment report on Friday is expected to show that about 500,000 new jobs were created and that the unemployment rate dipped to 5.1% from 5.2%. The ADP National Employment report for September is forecast to show an increase of about 475,000 new private-sector jobs.

Third quarter earnings season begins in earnest next week and there are only a few companies scheduled to report earnings this week. The most notable of these are PepsiCo, Constellation Brands, Conagra Brands and Levi Strauss.

Portfolio Strategy

Although October is remembered most for stock market crashes that occurred in 1929 and 1987, the month as well as the fourth quarter are generally positive ones for stocks. However, there are a number of potential obstacles that the market faces which could result in increased volatility that may test investors’ nerves. Among these are the September jobs report this week, Federal Reserve monetary policy, interest rates and inflation, the government debt ceiling, Chinese real estate developer Evergrande and last but not least, the spread of the Delta variant of Covid-19. Last week there was good news with regard to Covid as pharmaceutical giant Merck said that its oral antiviral treatment for the virus reduced the risk of hospitalization or death by 50% for patients with mild or moderate cases. The company plans to seek emergency use authorization from the FDA for treatment. Positive cases appear to be slowing, which should help the economy recover more quickly. The September employment report will give investors a good indication as to whether or not people are comfortable returning to work. The August job numbers were very weak, about 500,000 less than forecast. Another weak jobs report could delay the Federal Reserve’s announcement about when it will start tapering its bond-buying program, which many think will be in November. Higher than expected inflation that may not be transitory as the Fed claims is also causing bond yields to rise as the 10-year Treasury yield rose as high as 1.56% last week before settling at 1.48%. While Congress averted a government shutdown last week by extending the deadline, it failed to raise the debt ceiling, which is a bigger concern as it could lead to a U.S. default. Next week also marks the beginning of third quarter earnings season. Strong earnings so far this year have propelled the market higher, but supply chain disruptions could affect quarterly results and cause companies to temper their earnings estimates for the balance of the year.