Weakest Week of the Year, Where Markets Stand, Whole Bunch of Ugly, Fed Meeting

The week following the September 'triple-witching' expirations event, which was this past Friday, is often the worst week for U.S. market performance for the entire year.

"And the wild things roared their terrible roars and gnashed their terrible teeth and rolled their terrible eyes and showed their terrible claws."

-- "Where The Wild Things Are" Maurice Sendak (1963)

The How and When

That was a tough week. The last trading day of the week was special. Trading volume was tremendous, as was expected. Everything that can expire, did expire this past Friday. As happens four times a year. The witches were out.

The S&P 500 closed below its 50-day simple moving average (SMA) on Friday. As did the Nasdaq Composite and the Nasdaq 100. As the Dow Transports had more than two weeks ago. As the Philadelphia semiconductor had back in mid-August.

The small-cap indexes? The Russell 2000 not only surrendered its 50-day SMA a couple of weeks ago. but fought a daily battle last week to hold on to its 200-day line, a line its cousin, the S&P 600, hasn't even touched since September 6. Late-cycle trading activity? Some might say.

Corporate margins now fight the same losing battle now fought by corporate earnings for the past nine months. Inflation is slowing, so they say, as crude oil and gasoline continue to rip the cover off of the ball, and suck the discretion out of discretionary spending. For the U.S. consumer. As both large and small businesses face uncertainty.

Goldilocks will save us. We are told. The porridge is just right. We're headed for a soft, no make that "no" landing at all. Even if we pretend that the U.S. did not already go through a six-month economic recession at the start of 2022 (which is what we did -- "pretend" -- because the public did not feel that one broadly). Still the size of the U.S. economy contracted for two straight quarters. We're out of the woods though. Aren't we?

Into the Woods

I was rather lucky. I know how to read a map and can navigate (on foot, alone) well using a compass, a pencil and protractor.

It came easy to me. Some kids have a lot of difficulty picking this stuff up. Sure, it's easy when there's a water tower in the distance, a church over there somewhere. A road or two is clearly visible. Any landmarks at all. Now do the desert. Or worse, try the rainforest. Shoot an azimuth in the jungle, and you might walk six or seven feet without having to move around an obstacle and reshoot that azimuth. Again and again. Each time increasing the likelihood of human error. Slight error here could mean half a mile there.

Know your stride. Count your steps. No GPS. Hasn't even been invented yet. You've got to know how far you've traveled and you've got to know that you're not walking in circles. Why? Because walking in a circle is a human tendency. Oh, and because, you'll die out there. You can't even call in a medivac or supporting fire if you don't know where the heck you are.

So, where the heck are we? You want to talk about lag effects? No? Too bad. Fact of life. The FOMC started raising rates about 17 months ago. The experts (academic economists with fancy degrees from fancy universities) say that the economy usually starts to run into real trouble about 18 months, up to 24 months after the Fed starts tightening monetary policy. Using that quasi-rule as guidance, if we had already gone into overt economic contraction, it would have been early.

How long has the yield for the U.S. 10-Year Note been inverted versus the yield of the U.S. 2-Year Note and held that inversion?

The chart, above, says that this inversion has now held since July 2022. That's 14 months, gang. Those experts mentioned above say that the average lag between sustained inversion and recession (since 1978) is about 15 months, but can take as much as 22 months. Again, living by this metric, if we had already gone into recession, we would have been early. Catching on yet?

Good thing there is no lag effect between the implementation of tighter monetary policy and its real feel on Main Street, USA, right?. Oh, wait... you mean there is. Let's ask those experts. Here there is a wide variance in expectation. Some say six months. Others say two years. Even if we say that due to modern technology and the speed in the flow of information in 2023 that this lag has been shortened... if we put said lag at nine months, that puts Main Street where the Fed was back in December/January. Egads.

 

That means that the general economy is still four rate hikes behind the FOMC, while M2 Money Supply has shrunk by some $320B (or so). That adds up to a whole bunch of ugly, and it's still on the way. That also assumes that the Fed stops right here, which it really can not. Why? Because inflation is still too high. Why? Because that M2 Money Supply still stands up about 35% from where it was in February of 2020. There's still too much slosh.

So, Where Were We?

Oh yeah, the consumer is in great shape. The consumer will carry us all to victory. Except we now know that real wages are in decline. We now know that median household incomes, according to the New York Fed, have contracted for three years running while inflation has trampled the lower to middle classes. Childhood poverty has more than doubled since 2021. Revolving debt (credit cards) is at new highs as are the interest rates they charge. As are delinquencies. Oh joy. Savings? Don't ask.

 

All as the U.S. dollar hits new six month highs. Imagine where oil and gasoline would trade if the U.S. dollar were weaker against its reserve currency peers. These are oil and gas prices, rising rapidly, while benefiting greatly from our national ability to export inflation. Huzzah. Deflationary currency markets that should force prices lower, but instead will only hurt large-cap multinational corporations. Oh, we're cooking with gas now, my friends.

What Else?

-- China's economy is back on track (No, it certainly is not).

-- The UAW is not out on strike (Oh boy. They sure are and they are asking for wages and benefits that will likely put their members out of work while bankrupting their members' employers in five to 10 years.)

-- The U.S. government is not facing a potential shutdown in two weeks (wrong answer).

 

-- August Retail Sales were hot (Not if one takes out gasoline and energy).

 

-- Consumer and producer level inflation are cooling. (They're actually not, they have been heating up at the headline level for two months now and the headline level is what folks and businesses actually pay.)

Now Hear This

We entered into August telling you that August and September were the weakest months of the year historically for U.S. financial markets. We repeated the mantra coming into September, which is easily the worst of the two. Unfortunately, so far, we have been spot on this year.

 

Now for the real minutia. Late September is usually worse than early September. As a matter of fact, historically speaking, the week that you and I have just entered is the weakest week of the year. Ooh-rah.

 

The week following the September "triple-witching" expirations event, which was this past Friday, is often the worst week for U.S. market performance for the entire year. Is Santa Claus on his way? Historically... yes. That doesn't mean it's OK to walk right into a sucker punch.

 

Maybe some of you have never been punched in the face. It rots. Your teeth hurt. If you don't see it coming, you usually bite your tongue. Broken noses and even worse, broken jaws happen. In short, it's a lot worse than what you see in the movies. Stay guarded for now. Everything for a reason. Respect targets, pivots and panic points. You know how to do this.

Earnings Await

The big banks that kick off earnings season, JPMorgan Chase ( JPM) , Citigroup ( C) , and Wells Fargo ( WFC) , will all report their third quarters on Friday, October 13. We're still almost a month away. Using FactSet as my guide, as I always have and always do, the current (third) quarter is currently seen growing S&P 500 earnings by 0.2% (down from 0.5% growth just one week ago) on revenue growth of 1.5% (down from 1.6%).

 

If this result does come to realization, it would put an end to a three-quarter losing streak for the S&P 500. Yes, that means that the S&P 500 has suffered nine months of negative year-over-year earnings growth. Consensus view is (somehow) for a red hot fourth quarter for the S&P 500 -- earnings growth of 8.2% on revenue growth of 2.4%. That would allow the S&P 500 for the calendar year to end up growing earnings 1.2% and revenues 2.4%. I'm not holding my breath.

 

Looking ahead (still using data provided by FactSet), the current quarter is still expected to sport eight sectors with positive earnings growth led by Communication Services (+32.5%) and three sectors sliding into year-over-year earnings contraction, led to the downside by Energy (-40.1%). As far as revenue is concerned, Consumer Discretionaries are expected to lead nine sectors into positive territory at merely +7.1%, while Energy will again be the underperformer at -19.9%.

 

Currently, the S&P 500 trades at 18.8 (up from 18.6 last week) times 12-month forward-looking earnings. This is now above both the S&P's five-year average of 18.7 times as well as its 10-year average of 17.4 times.

 

What could possibly go wrong?

The Indexes

Equity markets had a really lousy week last week, as trading volume grew heavier throughout the five-day period. Actually, it was the end of the week that got ugly.

 

Readers are quite familiar by now with the double-top reversal experienced by the Nasdaq Composite this past July that produced the ongoing volatility and selloff currently impacting that index.

 

 

Note that just in the past week alone the Nasdaq Composite had retaken both its 21-day exponential moving average (EMA) and 50-day SMA twice and then surrendered both of those lines, twice. The pivot from that double reversal in July has formed as algorithmic resistance. The index has been unable to take and hold that area despite having had pierced the level from below as August turned into September.

 

As mentioned here last week, and mentioned often in general, a failure to retake the 50-day SMA could set up acceleration to the downside as portfolio managers will be forced to reduce long-side exposure to the largest names in the index.

 

The S&P 500 also had a tough ending to the week. Readers will see how what had started to look like a head-and-shoulders ( as pointed out by Doug Kass) pattern has evolved in a very strange way. For one, the right shoulder had apexed higher than the left shoulder, which for some technicians would negate the entire pattern. In addition to this, that right shoulder has added a double hitch. I would not be too quick to discount this shoulder as it still appears to be trying to round, and if it rounds, that means the 50-day line will be lost.

 

That forces PMs to sell stock. It's not rocket science, gang. The level that I'm watching is still 4335. That was neckline support for the development of that right shoulder. You crack 4335 support and you probably crack the S&P 500. Maybe all the way back to 4200. Nothing, however, is written in stone. Or blood.

 

 

Let's take a look at the small-caps, as they are exhibiting some late-cycle behavior:

 

 

The iShares Russell 2000 ETF ( IWM) now also looks to have added that double hitch to the still-developing head-and-shoulders pattern with an elevated right shoulder. The difference here is that the 200-day SMA has been tested (and held) four times and also just happens to be neckline support.

 

What does that mean? Well, sometimes you knock on a door a few times and you give up and walk away. Other times, the door opens. That would be bad.

Marketplace

For the past week, the S&P 500 gave back just 0.16%, after a loss of 1.22% on Friday, which flipped the entire week on its ear. The S&P 500 closed last week up 15.91% year to date.

The Nasdaq Composite was hit for a loss of 0.39% over the past five business days, after getting slapped around for a loss of 1.56% on Friday. This puts the Nasdaq Composite up 30.97% for 2023.

The higher tech, more narrowly focused Nasdaq 100 closed down 1.75% last week. The Nasdaq 100 is up a still (but less) impressive 38.96% year to date.

The Philadelphia Semiconductor Index was our leader last week, but in the wrong direction. That index gave up 2.51% over the past week. after losing 3.01% on Friday. The "SOX" now stands up 37.29% for the year, which is down from being up 40.83% a week ago.

That leaves us with the Russell 2000. The small-cap index gave up 1.05% on Friday, but just 0.24% for the week. The Russell 2000 now stands up 4.87% for 2023.

Other equity indexes of note that actually closed in the green for the past week, even if just by a smidge, were the KBW Bank Index (+2.39%), the Dow Transports (+0.86%) and the S&P SmallCap 600 (+0.08%).

All 11 S&P sector-select SPDR ETFs shaded red this past multiple expirations Friday. However, seven of these sector funds shaded green for the week. For the week, the Utilities (XLU) easily led the way at +2.79%, with the Discretionaries (XLY) and the Financials (XLF) both gaining more than 1%. Technology (XLK) was the big loser for the week at -2.25%.

The Week Ahead

Key to this week, beyond anything else, will easily be what the Fed does, says and implies this Wednesday. Keep in mind that both the Bank of England and the Bank of Japan will hold policy meetings this Thursday. They, too, have the ability to shift currency valuations, that then impact commodity as well as large-cap multinational large-cap equity prices.

The Fed

The Fed's media "blackout period" comes to an end this week with the September 20 (Wednesday) policy decision that comes along with the Fed's quarterly economic projections and the semi-ridiculous dot plot.

The FOMC is going to have to regain some flexibility that has been priced out of the marketplace. The last thing the Fed needs is to surprise the markets with a raise in rates on November 1 or December 13. So, either in the official statement, in the economic projections/dot plot, or in the press conference (probably all three), the Fed is going to have to leave you thinking that this is a "hawkish" skip, even if they have to scare you to do so.

As Sunday night slowly melts into Monday morning, I see that market pricing in a 99% probability for no rate change on September 20, and a 58% likelihood that the FOMC is done raising rates for this cycle. These markets are also pricing in a 53% probability that the Fed starts cutting rates by June 12, which would be the first of just three short-term rate cuts (down from four this time last week) in 2024.

Macro Attack

Away from that Fed decision this Wednesday, the week will be less active than we experienced last week. That said, there will be enough important macro to keep traders and investors occupied.

Tuesday brings August Housing Starts and Building Permits along with an auction of $13B worth of U.S. 20-Year Bonds. On Thursday, the Philadelphia Fed will publish their regional manufacturing survey, which just happens to be the most closely followed regional manufacturing survey in the country. We'll also see Existing Home sales for August and the Conference Board's Index of leading Indicators, also for August. This Friday, S&P Global will hit us with their flash PMIs for both the manufacturing and service sides of the economy on the national level.

Corporate

The Detroit Auto Show began last week and will continue through this week even as the UAW strikes against Ford Motor (F) , General Motors (GM) and Stellantis (STLA) . The show includes more electric vehicles than ever, which is ironic as this dispute between management and labor almost certainly forces EV-related plans for 2023 to be pushed out into 2024, at a minimum.

Oracle (ORCL) will also hold their four-day CloudWorld Event in Las Vegas this week. Uber (UBER) CEO Dara Khosrowshahi is expected to be a key speaker at the event.

Microsoft (MSFT) will hold a special one-day event this Thursday in New York City to feature upcoming hardware products as well as updates on the firm's latest innovations in the burgeoning field of generative artificial intelligence.

This will be an extraordinarily light earnings week, the lightest in quite some time. Still, there will be a few well-known names that are ready to step to the plate. We'll hear from AutoZone (AZO) on Tuesday, followed by General Mills (GIS) and FedEx (FDX) on Wednesday. Darden Restaurants (DRI) will wrap up the week from an earnings-based perspective on Thursday morning.

Economics (All Times Eastern)

10:00 - NAHB Housing Market Index (Sep): Expecting 50, Last 50.

16:00 - BNet Long-Term TIC Flows (Jul): Last $195.9B.

The Fed (All Times Eastern)

Fed Blackout Period.

Today's Earnings Highlights (Consensus EPS Expectations)

After the Close: (SFIX) (-0.21)

positions: Long ORCL, MSFT equity.