Sour Expectations Take Down the Market

Jacob Hess
October 05, 2021

The Week Behind

Turbulence has finally hit the equity market after a rather quiet summer of expansion. This past week saw volatility build on the week before leading the S&P 500 down -2.21% and the Nasdaq Composite down -3.20%. Investors were in risk off mode as the seasonally weak September ended. Over the course of the month, the VIX index jumped over 40% while the S&P 500 index fell a total of -4.76%. It seemed about time for a correction, and pressure from various negative macroeconomic factors had built up over the summer.

Is it just a coincidence that stocks saw red in the week following the September FOMC meeting? Many wouldn't be surprised if we see another rendition of the "Taper Tantrum" that caused volatility in markets in 2013, and this could be investors' reactions they were looking for. Yields on 2-year, 3-year, and 5-year Treasury notes have all increased since the beginning of August as the bond market senses a Fed hawkish streak. There has also been some reaction in currency markets with the USD rising against other key developed markets that are expected to be more dovish in its policy normalization: up 2.02% against the EUR and up 1.16% against the JPY. It's also worth noting that these two countries have seen lower spikes in inflation.

Typically a rise in yields indicates expectations of healthy growth which has been the case for the most of 2021. COVID restrictions were lifted in the United States and most other developed nations which led to a boom in growth after the contraction in 2020. The expectations of a boom spurred on pent up demand fueled by excess savings from unprecedented governmental support to consumer and businesses. This had all created a healthy environment for equities to grow in the first half of 2021. However, that environment has more or less eroded in the short-term creating an instance where future growth is uncertain. In the Chart of the Week, one can see a massive dip in the sentiment of manufacturers, not due to demand issues but due to supply issues, and that has by and large been the main driver of the weakness in September trading.

So where do we go from here? We've already seen some stabilization in trading in the beginning of October. Two strong positive performances by the S&P 500 on Oct 3rd and Oct 5th seem to have stopped the bleeding at around 4,300, and the 2-year Treasury found a bottom as well around the 27 basis point level. Pessimism seems to have calmed. Zurich Insurance seems to agree, leading its monthly analysis with: "We believe investor pessimism is likely to ebb in coming weeks." It points out that the AAII survey signaled a "pervasive downbeat sentiment" that it is a "contrarian indicator." If we see a bounce from this position, it suggests that investors believe that perverse macro conditions are likely a temporary phenomenon.

Chart of the Week


The manufacturing PMIs from the Dallas Fed, the New York Fed, and the Philadelphia Fed measure firms current business activity and business activity expected in the future. This chart measures the spread between current conditions and future conditions. In September, the spread at 3.4 pts reached the lowest point since June 2006 when it was negative at -1.0 pts.

The Week Ahead

The labor report is still to come this week and will play a huge role in how the market sees the Fed's tapering schedule. The August jobs report was a bit of a disappointment, so a rebound is expected. Canada's labor force survey also comes out on Friday and will also serve as an indicator in how the Bank of Canada will proceed with tapering.