Cooler inflation, hotter yields — Wall Street’s rally gets ambushed at Qtr end

And just like that - there goes the rally….and there goes the quarter!

Stocks spent much of Wednesday celebrating a cooler inflation report -then the final hour arrived and sellers took control, erasing most of the gains and sharply reducing the Nasdaq’s advance, leaving investors bruised as they continue to question if stocks can keep pushing higher even as the 10 yr continues climbing?

We can also point to the calendar……timing is also likely partly to blame. It was both month-end AND quarter-end, when institutions rebalance portfolios and adjust exposures. Some managers also engage in ‘window dressing’ which meand they clean up the holdings investors will see in their quarter-end reports.

(For those of you who don’t know what that is – it is when portfolio managers adjust their holdings at quarter-end to make the portfolio look better when the report cards go out to investors. They sell the stocks that performed poorly so that those names don’t appear among their quarter-end holdings. At the same time, they buy recent winners, making the portfolio ‘look’ as though it participated in those gains. But here’s the catch - the holdings show what the fund owned on the reporting date, not necessarily what it owned throughout the quarter. Thus, the name ‘window dressing’. To be clear that is different than rebalancing, which brings allocations back to their portfolio target weightings).

That window dressing likely added to some of the selling - but we cannot pin the entire reversal on the calendar or that action. The bond market and the oil market continue to be a source of angst and pressure as well.

At 4 pm – we saw the Dow down 443 pts or 0.9%, the S&P down 19 pts or 0.25%, the Nasdaq gained 63 pts or 0.25%, the Russell lost 11 pts or 0.4%, the Transports gave back 268 pts or 1.4%, the Equal Weight S&P lost 10 pts or 0.1% while the Mag 7 added 120 pts or 0.3%.

By the end of the day – every sector with the exception of tech was in the RED…. Industrials, Financials, Consumer Staples and Healthcare all taking it on the chin – losing more than 1%. Of the 11 S&P sectors – 3 are now negative on the year – Financials – 2.5%, Consumer Discretionary – 6.3% and Utilities – 7.6%.

On the upside – Energy is the clear winner this year – up 37.4% ytd…. Tech up 27.5%, Healthcare +8.7%, Industrials up 7.6%, Basic Materials are up 7.5%, Consumer Staples are ahead by 4.1%, Communications + 3.9% while Real Estate is squeaking by – up 2.7%.

Bonds lost more ground – the TLT down 0.6% yesterday – leaving that down 10.7% on the year while the TLH gave up 0.4% leaving that down 9.3% ytd. The 10-yr yield is now 5.28% up 4 bps – now at a 19-yr high and the 30-yr yield to 5.62% up 6 bps….30 yr mortgages are now pricing at better then 7%.

And oil - that didn’t quit either…. WTI rose 1.2% to settle at $90.42, while Brent gained 91 cents to settle at $103.50—even as Gulf exports approached “normal” levels. So, then you ask—why did oil advance?

Well, because investors/traders want to be assured that the recovery is real. Talks between the US and Iran have stalled again, and the risk of a renewed disruption remains ‘real’ and that will keep traders pricing in a risk premium. Meanwhile, the EIA reported that distillate inventories - which include diesel and heating oil - fell by 2.3 million barrels last week, suggesting supply concerns as we move into fall and winter.

But there was some good news in all of this…..we ARE seeing some relief in diesel…. The national average is down by about 12 cts and is now $6.41/gal vs. the $6.53/gal last week. And while that is encouraging, let’s not get carried away - transportation costs remain high and while we are seeing more ‘normal’ levels of crude making its way thru the strait, it takes time for it to work its way thru the system and translate into cheaper prices at the pump. For now, the chart tells us that we are in the $85.70/$100 trading range.

And then we had better than expected economic data….. We got cooler inflation AND stronger economic growth. And while that is a combo that investors (and the FED) should welcome, the excitement did not last and neither did the early relief we saw in bonds. At the end of the day – yields advanced and stocks got kicked in the gut.

Let’s start with inflation. August headline PCE rose 0.3% for the month, with the annual rate coming in at 3.4%, below the expected 3.7%. Core PCE excludes food and energy—rose 0.2%, below the expected 0.3%, while the annual rate came in at 3%, below the expected 3.3%. July’s monthly core reading was also revised down to 0.1%. That headline gave investors some breathing room and reduced the immediate pressure for another Fed hike. In fact – the odds of an October rate hike collapsed and are now only 39% vs. the 81% last Friday.

But let me be clear…..part of the improvement in the data point came from changes in HOW the BEA measures prices for software and accessories, portfolio management fees and legal services.

Then there is the timing issue – remember this was the AUGUST inflation report – it does NOT capture the September’s surge in diesel prices. So, yes - the report was encouraging, but traders immediately started to speculate what the September read is going to look like and as you can guess – they are cautious and when they are cautious – we usually get a ‘shoot first and ask questions later’ type of reaction.

Meanwhile, 2^nd quarter GDP was revised UP to a 2.2% annualized growth rate from the previously reported 1.5%. Consumer spending grew at a healthy 3.8% annualized pace, while stronger business investment – think spending associated with the AI infrastructure buildout and that helped lift the growth estimate.

August Personal Spending jumped by 0.9%,while Personal Income failed to impress – rising just 0.2% vs. the +0.5% expectation. And that’s a problem…. spending vs. income.

September’s ADP employment report was good - private employers added 90,000 new jobs vs. the expected 75k.

Put it all together and you can see the problem. Cooler inflation gives the Fed room to wait. Stronger growth and spending suggests demand remains resilient. Neither report says the economy is falling apart - but neither guarantees that interest rates are headed lower.

Gold struggled and ended the day down just a bit to $4,153/oz. My gut still says that rising Treasury yields continue to put pressure on gold. The chart suggests we are in the $4,000/$4,300 trading range.

So where does that leave us? Yesterday gave us encouraging economic news, but the market could not turn it into a convincing advance. Quarter-end flows likely contributed to the late selling, but rising yields remain the bigger concern.

Today is October 1^st, it is a new month and the beginning of the 4^th qtr., Halloween, Thanksgiving, Hannukah and Christmas are just weeks away….and then the ball drops in Times Square and a new year dawns.

Next – we have to see if the buyers get more aggressive or if the sellers continue to be aggressive now that the qtr. is over and the new qtr. begins. We have to see if the bond market gives us room to breathe. Friday’s jobs report and the September CPI and PPI reports will give investors more insight into the state of the economy while earnings will give us insight into what the C-suite thinks about the next 4 – 6 months.

Eco data today includes Challenger Job Cuts y/y which are expected to be down by 20% - that’s good. We will also get S&P Global Manufacturing PMI and ISM Manufacturing PMI- both expected to remain well into the expansion zone. ISM Price paid are expected to be higher – that is not good.

Last night – MU reported earnings….it was beat and raise qtr.- but expectations were high - the stock is down $6 in the pre-mkt.

European markets are all lower – down more than 1.5% across the board.

US futures are mixed. At 4:30 am - Dow futures are pointing down by 270 pts, the S&P’s -5, the Nasdaq is up 115 while the Russell is getting punched in the face – down 16 pts. I know it’s early and a lot can change, but it is what it is right now.

Recall our discussion last week about Dow Theory…. The Transports were flashing a warning, breaking down through all three support levels. Now the Dow Industrials are approaching their own long-term support near 50,250. Should that fail to hold, it would reinforce the warning coming from the Transports and suggest more difficult times ahead. Should it hold, that would offer some reassurance—but we would still need to see the Transports stabilize and turn higher to strengthen the case for a broader recovery.

The S&P closed yesterday at 7,651 down 19 pts. We are sitting right on top of the short-term trendline. The futures are suggesting it holds…but should it fail – then 7,560 is next and eve n that is only a 3% move off the high. Remember in August I said I expected to see an 8 – 10% pullback – into the fall and the midterms. So far - the Equal Weight S&P is down 6.6%, the Russell is down 8.9%, the Dow is down 6.6%, the Transports are down 15%, the Nasdaq is UP 2.5% while the S&P is essentially flat.

Pasta and peas

This is one of my daughter’s favorites dishes…..and btw – one of my favorite dishes too.

It’s simple and so easy to make…takes 30 mins start to finish.

Prep time: 10m

Cook time: 30m

Total time: 40m

Serves: 4-6

Ingredients

1 lb. elbow pasta, you can use med shells or orecchiette

1 lb. frozen peas, butter & olive oil.

1 lg Onion s&p Fresh grated Cheese (Parm or Pecorino)

Preparation

Step 1

Begin by bringing a pot of salted water to a rolling boil.

Step 2

In a large sauté heat up some oil and a dollop of butter.  Add in the sliced onion and sauté for 8 – 10 mins.

Step 3

Now add the peas and season with s&p.  Turn heat down to do med and cover – stir every 3 or 4 mins or so. Cook for 10 mins.  

Step 4

Now add the pasta to the pot – cook for 8 mins or so. 

Step 5

When the pasta is done – reserve a mugful of the pasta water and then strain.  Add the pasta to the sauté pan with the peas and mix well.  Add ½ of the pasta water to the pan to keep moist. 

Step 6

Next – toss in a handful of cheese and mix. Serve immediately. This is even better the next day!