10 things for investors to watch in the fourth quarter
Oil prices, US inflation, stimulus in China and earnings season are among the Top 10 things we’re watching in the fourth quarter.
Market-watchers widely anticipate the Federal Reserve (Fed) to start cutting rates at its meeting in September.
I explore the market’s reaction to the beginning of the Fed easing cycle in 1995 and some important differences between then and now.
I expect the Fed will cut only 25 basis points, but I anticipate that would only be the start of what is likely to be a very significant easing cycle.
In recent weeks, it’s become clear to me that the US is very likely to avoid recession and the US Federal Reserve (Fed) is very likely to begin cutting rates, and so my thoughts have increasingly turned to the 1994-1995 tightening cycle. I think we could all categorize it as a success story because it did not end in recession. While history doesn’t usually repeat itself, it often rhymes, so I’m hopeful there are lessons to be learned by studying what happened to markets as the Fed began to cut rates in 1995.
First, I think it’s important to establish the timeline1:
In general, returns were more muted in the subsequent six-month period (from Jan. 5, 1996, through July 5, 1996). The S&P 500 posted a gain but it was a more tepid 6.6%.2 Small-caps posted more modest gains as well, as did international stocks. 2 Bonds were also weaker. Growth outperformed value during this period, with the tech sector posting the biggest return (as represented by the S&P 500’s tech sector return of 15.10%). 2 My sense is that 75 basis points in rate cuts provided limited fuel for risk assets to move higher.
It’s important to note that the 1994-95 tightening cycle was considered “preemptive.” In other words, inflation was relatively low but the Fed was worried that inflation would rise significantly because of a tightening labor market. As then-Fed Chair Alan Greenspan explained in 1997 Congressional testimony, “In recognition of the lag in monetary policy’s impact on economic activity, a preemptive response to the potential for building inflationary pressures was made an important feature of policy. As a consequence, this approach elevated forecasting to an even more prominent place in policy deliberations.”3
When the Fed began to tighten in February 1994, unemployment was at 6.5%; it had fallen to 5.4% by February 1995 when the Fed stopped tightening, suggesting there was a significant lag to monetary policy – something Alan Greenspan noted.4 Unemployment was at 5.7% when the Fed started to ease in July 1995.3 When easing ended in January 1996, it had actually moved slightly higher, to 5.8%, again illustrating lagged effects.4
The 2022-2023 tightening cycle was far from preemptive – I would describe it as reactive and just plain late. Inflation had risen dramatically but had initially been dismissed as transitory before the Fed finally began to tighten in March 2022. But because of the nature of the post-COVID labor market, unemployment was significantly lower (it was 3.6% in March 2022)4 and, also owing to COVID policies, fiscal stimulus was abundant. In addition, many US consumers were sitting on homes they had already financed or re-financed with low long-term fixed rate mortgages, so they were more insulated from the impact of aggressive tightening.
My conclusion is that economic conditions were different back in 1995, with unemployment higher relative to today and a less resilient consumer. So while tightening was more aggressive in the most recent Fed cycle – hiking rates by 525 basis points in 2022-2023 versus 300 basis points in 1994-1995 – the economy has appeared more capable of withstanding the pressure. Also, rate cut expectations are very different today — there is an expectation of about 200 basis points in cuts in the next year,5 which would likely provide a far more powerful boost to risk assets in coming months than the tepid 75 basis points in cuts provided by the Fed from July 1995 through January 1996. Given this environment, markets are likely to discount an economic re-acceleration late in 2024 or early 2025, which I would anticipate resulting in strong performance from risk assets; more specifically, I would expect at least modest cyclical and small-cap outperformance. I would also anticipate a weakening US dollar, which could provide a tailwind to international equities. And I would expect gains from fixed income, especially high yield and municipal bonds, and real estate investment trusts (REITs).
Having said that, we must recognize that every monetary policy and economic environment is different, and thus every market environment is different. I wouldn’t be surprised to see significant market volatility and even some sell-offs in coming weeks – especially leading up to the Fed’s September meeting and again leading up to the November presidential election, but also in response to weak economic data since “bad news” is no longer “good news” but just plain old “bad news.”
We will be getting a number of country Purchasing Managers’ Indexes this week as well as the US Job Openings and Labor Turnover Survey Report report, which is helpful in gauging the tightness of the labor market. I am personally a big fan of the Federal Reserve Beige Book, which I always make sure to read since it usually provides some valuable insights. The Bank of Canada meets this week, and I am hopeful it will cut again, which should further increase the Fed’s comfort level with starting to ease.
The most watched data release this week is likely to be Friday’s US jobs report, and markets are already showing signs of nervousness about it. The most important metric in the report will be wage growth, and I anticipate it will be relatively modest. However, I can’t stress enough that whatever the report is, it should not derail the Fed from a rate cut in September. I expect the Fed will cut only 25 basis points, but I anticipate that would only be the start of what is likely to be a very significant easing cycle. And if the 1995-1996 easing playbook is a guide, I believe it’s likely to set up a positive climate for risk assets in coming months.
Date |
Event |
What it tells us |
---|---|---|
Sept. 3 |
US Manufacturing Purchasing Managers’ Index
|
Indicates the economic health of the manufacturing sector. |
|
US ISM Manufacturing Purchasing Managers’ Index
|
Indicates the economic health of the manufacturing sector. |
|
Canada Manufacturing Purchasing Managers’ Index
|
Indicates the economic health of the manufacturing sector. |
|
China Caixin Services Purchasing Managers’ Index
|
Indicates the economic health of the services sector. |
Sept. 4 |
Eurozone Services Purchasing Managers’ Index
|
Indicates the economic health of the services sector. |
|
UK Services Purchasing Managers’ Index
|
Indicates the economic health of the services sector. |
|
Eurozone Producer Price Index
|
Measures the change in prices paid to producers of goods and services |
|
Brazil Industrial Production
|
Indicates the economic health of the industrial sector. |
|
Bank of Canada Monetary Policy Decision |
Reveals the latest decision on the path of interest rates. |
|
US Job Openings and Labor Turnover Survey Report
|
Gathers data related to job openings, hires, and separations. |
|
Korea Gross Domestic Product
|
Measures a region’s economic activity |
|
US Federal Reserve Beige Book
|
Summarizes anecdotal information on current economic conditions in each of the Fed’s 12 districts. |
Sept. 5 |
Eurozone Retail Sales
|
Indicates the health of the retail sector. |
|
US Services Purchasing Managers’ Index
|
Indicates the economic health of the services sector. |
|
US ISM Non-Manufacturing Purchasing Managers’ Index
|
Indicates the economic health of the services sector. |
|
Japan Household Spending |
Indicates the health of the housing market. |
Sept. 5 |
US Employment Situation Report
|
Indicates the health of the job market. |
|
Eurozone Employment
|
Indicates the health of the job market. |
|
Eurozone Gross Domestic Product
|
Measures a region’s economic activity |
|
Canada Jobs Report
|
Indicates the health of the job market. |
10 things for investors to watch in the fourth quarter
Oil prices, US inflation, stimulus in China and earnings season are among the Top 10 things we’re watching in the fourth quarter.
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1 Source for all historical information about the level of US interest rates: US Federal Reserve as of Sept. 3, 2024
2 Source: Bloomberg, L.P., as of Sept. 3, 2024
3 Source: Alan Greenspan, Congressional testimony, January 1997
4 Source: US Bureau of Labor Statistics, as of Aug. 31, 2024
5 Source: CME Group Fed Watch Tool, as of Sept. 3, 2024
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
The opinions referenced above are those of the author as of 3 September 2024.
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Tightening monetary policy includes actions by a central bank to curb inflation.
A basis point is one-hundredth of a percentage point.
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