Contributors
Sarah Stillpass
Global Investment Strategist
September jitters
After a 1% gain in August, the S&P 500 closed out its first week of September down 3%.
While September has historically had the lowest average monthly return over the last 30 years, we think there is a bit more to the story than seasonality. For starters, the September Federal Reserve meeting is less than two weeks away and all eyes are on the labor market:
- The August jobs report was released on Friday. The data showed an acceleration of job growth to 142,000 positions added last month and a move down in the unemployment rate to 4.2% from 4.3% in July. That said, job growth over the prior two months was revised down by 89,000 jobs. The report is likely to be a major factor in the Federal Reserve’s decision to deliver a 25-basis-point or 50-basis-point rate cut. Immediately after the print, markets slightly increased the odds of a 50-basis-point move.
- U.S. manufacturing data suggested more sluggish activity. Even though the Institute for Supply Management (ISM) Manufacturing Index ticked up to 47.2 in August versus 46.8 in July, any reading below 50 indicates contraction. According to the ISM survey, manufacturing activity has now shrunk in 21 of the last 22 months, extending the second-longest downturn in history.
Elsewhere, a smattering of geopolitics, trade and commodity moves gave investors angst:
- Japanese restrictions on Chinese chipmakers added to increasing uncertainty around global chip supply chains. The semiconductor index was down 9% and Nvidia was down 10%.
- Oil prices broke $75 per barrel, selling off nearly 5% on Tuesday due to weak Chinese demand and excess supply.
It’s not all doom and gloom, however, as we saw other pockets of the market excel despite the sell-off. We’re calling this “A Tale of Two Markets.” In this week’s Top Market Takeaways, we dive into the “haves” and “have-nots” in markets and what it all may mean for your portfolio.
A Tale of Two Markets
“It was the best of times, it was the worst of times.” While the opening of Charles Dickens’ “A Tale of Two Cities” may be a bit dramatic to use here, we think it is an apt description of what we saw unfold over the last few days.
Let’s start with stocks:
1. The artificial intelligence (AI) trade felt the pain. Nvidia fell more than 10% on the week and set the record for largest single loss in market cap in history. Investors are starting to ask the same questions that our Chairman of Market and Investment Strategy, Michael Cembalest asked in his latest note, COVIDIA. Here are a couple factors:
- Hyperscaler capital expenditures are through the roof. Magnificent 7 capital spending now exceeds that of the entire energy sector. In fact, in the second quarter, hyperscalers have spent $53 billion on capex, up 58% year-over-year versus 30% in the first quarter. Investors tend to meet capital spending plans with more scrutiny because they want assurance that the investment is going to be worth it.
- If you build it, will they come? The first phase of the AI build out is deeply rooted in ensuring enough infrastructure is in place. That means building the basics, producing things like semiconductors, data centers and sourcing the energy needed to power AI models. On top of it all, the hyperscalers need to train those models. All of that seems to be progressing but the next leg of the journey is putting generative AI into practice to increase productivity and generate profits. While we have seen powerful examples of “inference tasks” like those from customer service provider, Klarna, broad adoption is still in its early days.
We are believers in the long-term investment potential of AI. Bad days are to be expected, but over the next decade, we see AI-linked names outperforming the broader market. We think the questions surrounding stretched valuations and fears of AI over-hype are healthy. Skepticism is a good thing, as it keeps markets in check and this week’s price action seems to be a momentum story, not one of economic fundamentals. Investors today require companies to “show” and not just “tell.”
Hyperscalers grew capex 58% year-over-year
Hyperscaler capex year-over-year growth, percentage
This chart shows hyperscaler spending from 4Q 2022 through 2Q 2024. It was 8.1% in 4Q 2022, -4.4% in 1Q 2023, -9.4% in 2Q23, -5.9% in 3Q 2023, 8.9% in 4Q 2023, 30.5% 1Q 2024, 58% in 2Q 2024.
Source: Bloomberg Finance L.P. Data as of August 27, 2024. Hyperscalers are MSFT, META, GOOGL, and AMZN.
2. On the flip side, defensive and certain interest rate sensitive stocks shined. Enter the “boring is not bad” story. While the risks of an economic slowdown may make some investors feel like adding to risk is a not-so-good idea, opportunities across sectors still exist.
The Federal Reserve is prepared to cut rates this month, and that means the “Fed put” is in play. In other words, declining interest rates may support outperformance of more interest rate sensitive sectors.
This week, only three of the 11 S&P 500 sectors landed in the green: consumer staples, utilities and real estate. While other traditionally defensive sectors like financials and health care were down on the week, they outperformed tech by almost double. Defensive stocks, for example, tend to be less sensitive to the ebbs and flows of the economic cycle. This means they may have the ability to produce more durable cash flows and consistent revenues. Earnings estimates show the health care, industrial and consumer staples (to name just a handful) sectors growing into 2025.
Our base case still calls for a soft landing, but as economic activity inevitably slows to more normalized levels, we think it is apt to examine sector balances and risk exposures in portfolios. For investors that are feeling “big-tech fatigue,” looking across more defensive sectors could be compelling. Take today as an opportunity to assess strong performance from year-to-date portfolio standouts, as they may have put portfolios offsides in terms of desired allocations.
3. Oil prices are off more than 16% from July highs, and are at year-to-date lows. Fears surrounding a resumption of Libyan oil production, Chinese demand concerns and a mixed narrative on OPEC+ supply levels sent oil prices lower this week.
OPEC+ said in June it would restore production by 2.2 million barrels per day starting in October after a period of cuts – but has since waffled. Rumors mounted on Wednesday followed by an official announcement on Thursday that the proposed supply increase would be put on pause until January.
We do not think a two-month production delay takes away the fact that production will increase sometime this year. To boot, weak Chinese demand and oversupply elsewhere are likely to outweigh the measures. Thus, we see prices moving to $81 to $86 per barrel by year end. That said, factors like unrelenting geopolitical tensions and the upcoming U.S. presidential election could spur price action.
4. Corporate credit had a banner week. This week was one of the biggest on record for investment-grade bond sales led by over 50 firms. September is typically a busy month for issuers as investors return from summer vacations, and the day after Labor Day is historically one of the busiest days.
On Tuesday alone, a record 29 borrowers including Target, Ford and Barclays issued investment-grade bonds. Beyond seasonal factors, corporations are moving to lock in borrowing costs while yields are relatively low. First time IG borrower Uber tapped the market on Thursday. Corporates are taking advantage of all-in, investment-grade yields that have come down from a year-to-date high of 5.85% in April to 5.04% today.
We think credit is the foundation of markets. Borrower fundamentals look to be rock solid and investor demand is strong. Five-year credit spreads across investment-grade maturities remain tight relative to historical medians. At the same time, all-in yields are elevated and that could create a compelling opportunity for investors to lock in yields.
Boring is not bad. Investors should take comfort in the fact that bonds are there to provide a buffer against the shorter term volatility that we might see in higher growth investments (like artificial intelligence).
Corporate bond spreads ticked up but are low relative to history
5-year investment grade spreads
The chart tracks the spreads of investment-grade bonds over a period extending from January 4, 2008, to August 30, 2024. The spreads are measured on a weekly basis and reflect the risk premium that investors demand for holding corporate bonds over risk-free government securities.
During the 2008 Financial Crisis, spreads rose sharply from 191.2 basis points in early January to a peak of 588.1 basis points in late October, reflecting severe market turmoil. The post-crisis recovery (2009-2010) saw spreads gradually decline from 575.3 basis points in December 2008 to below 150 basis points by the end of 2010.
The European Debt Crisis (2011-2012) caused spreads to rise again, peaking at 256.4 basis points in October 2011, before decreasing to 122.1 basis points by December 2012. From 2013 to 2019, spreads remained relatively stable, averaging around 100-150 basis points, with minor fluctuations.
The COVID-19 pandemic in early 2020 led to a significant spike in spreads, peaking at 397.1 basis points in March. This was followed by a rapid decline as monetary and fiscal interventions stabilized the market, bringing spreads down to 103.6 basis points by the end of 2023.
In recent trends (2021-2024), spreads remained low and stable in 2021, averaging 70-80 basis points. They increased in 2022 due to rising inflation and geopolitical tensions, peaking at 152.6 basis points in September. The year 2023 saw volatility with spreads fluctuating between 100 and 140 basis points, before generally declining to 92.1 basis points by August 2024.
The data shows how investment-grade bond spreads have responded to major economic events and market conditions over the years. From the peaks of the 2008 financial crisis and the COVID-19 pandemic to periods of relative stability and low volatility, the spreads reflect investor sentiment and risk appetite across different economic cycles. The most recent data indicates a return to more normalized spreads, albeit with some fluctuations, as markets continue to adapt to evolving economic landscapes.
Source: Bloomberg Finance L.P. Data as of August 30, 2024.
While each asset class has a distinct (and important) role in portfolios, both good and bad days are inevitable. The ultimate key to notching consistent returns over the long haul is diversification across asset classes and rightsizing positions.
As the Federal Reserve prepares to cut interest rates in the coming weeks, we encourage investors to review their asset allocation, particularly when it comes to excess cash.
For those looking to add to an already diversified portfolio or diversify further, we see opportunity in adding high quality, income yielding stocks and investment-grade fixed income (including municipal bonds for U.S. taxpayers).
At the end of the day, sell-offs are a feature – not a bug – of investing, and it is important to keep it all in perspective.
While past performance is no guarantee of future results, the past 13 times the first day of the month was down 2% or more (like it was in September), the market was higher in the remainder of the month every time. Here’s to September being number 14.
And as always, your J.P. Morgan advisor is here to help you think through what this could all mean for your portfolio.
All market and economic data as of 09/06/2024 are sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
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The information presented is not intended to be making value judgments on the preferred outcome of any government decision or political election.
The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to "stock market risk" meaning that stock prices in general may decline over short or extended periods of time.
In general, the bond market is volatile and bond prices rise when interest rates fall and vice versa. Longer term securities are more prone to price fluctuation than shorter term securities. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss. Dependable income is subject to the credit risk of the issuer of the bond. If an issuer defaults no future income payments will be made.
Investors should understand the potential tax liabilities surrounding a municipal bond purchase. Certain municipal bonds are federally taxed if the holder is subject to alternative minimum tax. Capital gains, if any, are federally taxable. The investor should note that the income from tax-free municipal bond funds may be subject to state and local taxation and the Alternative Minimum Tax (AMT).
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