Weekly Recap:

by Eric Criscuolo & Michael Reinking, CFA

Last week we discussed the main themes driving markets: the broadening of the Middle East conflict, rising yields and AI. The Iran conflict spread to Yemen as the Houthis took substantial territory and threatened to create another supply chokepoint in the Red Sea. Inflation reports remained elevated. Crude rose another 10%. Global yields jumped, taking the 10-year Treasury to 5.0%. These weren't exactly new catalysts but we did add one new brick to the wall of worry: the possibility that AI destroys the human race. 10% chance- at least- according to some. The S&P ended the week down almost 1% with small caps losing about twice that. Energy was the obvious leader and Tech outperformed due to semiconductor-related strength.

This week started on a strong note as Skynet didn't become self-aware. In another miracle, both the Giants and Jets won their opening day games for the first time since 2009.

Unfortunately, the expected meeting between Gulf states and Iran over the weekend was postponed and the Houthis continued to capture territory. That drove oil higher and kept the pressure on equities. Adding to that strain was the latest plot twist in the AI story. Anthropic’s CEO published an essay calling for the slowdown of AI model development, in order to keep the Skynet scenario from happening, basically. Other AI leaders voiced their support, but many others didn’t, including the President of the United States. Needless to say AI hardware and infrastructure names began the week by selling off (DRAM and ICE Semis down >5% on Monday). However, the countertrade to that was turbo-charged, as software stocks rose sharply (IGV +5%).

Oil continued to climb on news around Libyan production issues and strikes on Russian refineries. The S&P’s 50d moving average around 7615 failed to hold, and then the index fell below 7600, the bottom of the trading range it’s been in since early August. The TL;DR: The Middle East, yields and AI continue to be the major themes driving markets. And they probably will be for the foreseeable future.

This week's big market event would play directly into one of those themes: the Federal Reserve’s rate decision. Before getting into that, however, we'll briefly mention the news that Warren Buffett announced he’s stepping down as Chairman of Berkshire Hathaway, effective immediately. What an incredible run.

Back to the Fed. A 25bp rate hike was the overwhelming expectation and that is exactly what happened. The new Summary of Economic Projections (SEP), which were last updated three months ago, along with Fed chair Warsh’s Q&A session were the the main points of interest. We discuss more below, but the immediate results was yields ripping higher, especially on the front end. The 2y traded up 15bp from the day’s lows. The S&P fell to its 100d moving average ~7515 but support held and it recovered some of the loss into the close. The next day however the index jumped 1%, regaining the 50d and returned back into that 7600-7800 range we've been noting. Equities benefited as yields pulled back, erasing all of the 2y’s post-decision rip, and oil fell on some optimistic geopolitical news (also discussed below).

The Fed decision came right before a huge Quad Witching (welcome back single stock futures) on Friday, as well as index rebalances. It was the third-largest closing auction in NYSE history, at 3.5 billion shares, while notional was a record $244.9 billion. All of this created an enormous amount of market noise, making the overall moves a little harder to disentangle as mechanical flows from options and futures expirations, repositioning and treasury market gyrations flooded the market.

The late-week rally put the S&P 500 only slightly lower for the week. Mega caps limited overall weakness, however. The equal-weight is down over 1% and small caps closer to 2% while the NYSE 100 ended up ~1%. On Friday the S&P once again tested support at its 50d ma just above 7600 but bounced off it. The thematic and high beta baskets we track like quantum and space and rare earths (and quantum space data center mines on asteroids) were mixed but most came under pressure on Friday, coinciding with sharp rally in crypto. If crypto continues to wake up it's possible we see flows durably rotate from those groups into the crypto complex.  

Only 3 sectors were up up for the week:

Healthcare led. Life science tools were among the best performers on some positive updates at investor conferences and there was strength across the rest of the sector, including Med Devices, a YTD underperformer. On the other hand Services and managed care.

Communication Services was also near the top with the mega caps Alphabet and Meta +3%, but the rest was lower, including Netflix (-7%) which caught a downgrade to Underweight on Friday.

Tech was around flat but rallied into Friday's close and the big opex, driven by semis, to finish the week as third sector in the green. It was volatile as a lot of AI news crossed the tape- calls for the AI slowdown mixed with corporate updates highlighting unrelenting demand (Jensen said NVDA chip shipments would double next year).

On the downside, Utilities and Real Estate lagged as yields rose. Financials were lower, continuing the weakness from last week as the yield curve continued to flatten, combined with some negative updates at investor conferences. Bank of America offered soft sales and trading guidance and Goldman Sachs had similar commentary on FICC trading. Huntington cut its outlook on higher funding rates and NII pressure. On the other hand, commentary on overall economic and credit conditions remained positive if not robust. The sector is also digesting the failure of the crypto Clarity Act in Congress and the SEC and CFTC taking matters into their own hands by issuing pieces of a regulatory framework for tokenization and trading.  

Materials lagged with weakness in agriculture names and steel (earnings) / miners. Industrials were also weaker. JB Hunt noted pricing pressures which weighed on trucking and freight peers while talk of slowing down AI development earlier in the week hit other infrastructure names like electrical equipment and construction.              

Consumer Discretionary and Staples continue to diverge, and the most recent move tracks closely with oil's sharp move higher. This despite generally upbeat commentary about economic resiliency and consumer spending. The chart below is a look at the equal-weight Discretionary versus Staples ratio, mitigating the over-influence of the mega caps.

One of the market characteristics we've highlighted was the high dispersion of returns across individual stocks being offset by very low correlations, keeping overall index volatility muted. That dynamic has been changing from its extremes in the summer. Correlations have been rising but individual stock volatility has been falling, keeping index vol relatively stable. This week we saw correlations come back in but remain in an uptrend.

The focus this week was more about the Federal Reserve as opposed to the economic data. The data itself continued to paint a similar picture of a resilient economy, consumer and labor market while the housing data once again highlighted underlying weakness.

Retail Sales beat expectations, both headline and the control group that feeds into GDP.  Headline rose 1.2% in August, more than reversing a decline in July (which was at least partially due to calendar effects from Prime Day) and seeing its highest growth in 5 months. The control advanced 1.4%, the highest in 2 years. 12 of the 13 major retail categories increased. Among the largest gainers, gas stations (no surprise) grew 3.1%, nonstore (online) retailers +2.6% and miscellaneous stores +1.9%.

The labor market looks healthy. Initial claims fell back below 200k and continuing claims fell to 1.73ml from 1.78ml last week, hitting its lowest level since May of 2024. The weekly ADP Employment Change also jumped to 16.25k from 12.25k. 

The housing data continued to highlight weakness. The NAHB Housing Market Index fell to 32 from 35 last month driven by a decline in sales expectations. The percentage of builders cutting price and using incentives both increased. Building permits and housing starts came in a touch below estimates and last month’s readings. August pending homes sales bounced back modestly after big declines in June and July. NAR Chief Economist Dr. Lawrence Yun noted, “Nationally, contract signings today are running roughly 30% below where they were in the years leading up to the pandemic.”

This week we also got our first look at September data with the release of the regional surveys. Both Empire and Philly manufacturing showed some moderation of activity after the big jump in August but remained firmly in growth territory. New orders and employment trends moderated while prices increased.

The data largely supported the first rate hike by the Federal Reserve since July of 2023. The decision to raise rates was unanimous which the Committee said “will support a timelier return” of inflation to their stated 2% target. The Summary of Economic Projection had a dovish tilt. The Committee projected inflation to ease significantly next year, largely in line with the June SEP, but it was notable that the Committee does not see core returning to target until 2029, which stretches the meaning of “timely”.  The DOTS showed broad support for an additional hike this year but for rates to hold steady throughout 2027. Chair Warsh’s press conference was short, ending abruptly at the 30 minute mark, and a bit more hawkish. The Chair suggested that the rate hike comes at a time when the economy seems to be strengthening and reiterated, “I would be hard-pressed to describe broad financial conditions as restrictive. This view was widely shared by the Committee. So, we removed a dose of accommodation.” This seems to suggest that the Committee is looking to unwind some if not all of the late 2024 cuts. 

For the week there was a flattening of the yield curve. The 2yr was up ~10bps to 4.75% which is 75bps above the current Fed Funds Target. The move in the long end was more moderate though markets are closely watching the 10yr which is sitting at the psychological 5% level. 

The USD moved higher throughout the week with much of strength coming against the Yen (more on that below).

Global Equities -  Most major indices ended modestly lower with geopolitics and rising oil/yields weighing on sentiment. 

Asia - a strong rally overnight recouped losses from earlier in the week.

Europe - Major indices tried to rally this week but today’s selloff wiped out those gains. The EuroStoxx index has closed lower in 5 of the last 6 weeks unwinding the August rally. Autos underperformed after Volkswagen cut guidance. Communication and retail stocks were some of the worst performing stocks while tech and pockets of healthcare outperformed. Overnight, ECB inflation expectations moved higher across all time horizons and Germany PPI came above estimates. This added to upward pressure on yields.

UK - The FTSE 100 ended the week around unchanged. In terms of economic data CPI was inline while PPI came in hot. This morning’s retail sales came in ahead of estimates. The Bank of England left rates unchanged in a 6-3 split vote. The central bank tweaked its QT program announcing slowing the pace from £70B to £46B announcing it would permanently hold long dated gilts on its books while bond with maturities ~2035 would be held to maturity and only passively runoff. 

The big event will be the Trump-Xi summit on Thursday. A dinner with AI leaders including Sam Altman and Jensen Huang will also be on the menu. Could turn into an Animal House-like food fight given all the "We need to all slow down!", "You can slow down if you want but I'm not!", "China wins if we slow down!" arguments that erupted this week. Speaking of arguments, the UN General Assembly meetings will also take place next week. The Fed media blackout ends, so we’ll start to hear from Fed officials about their thoughts on this week’s rate hike and overall views of monetary policy. The biggest data releases will be the global flash PMIs. On Tuesday we’ll officially say goodbye to Summer and usher in Fall as the autumnal equinox arrives for everyone in the Northern Hemisphere. Lastly, the NHL preseason begins as the sports calendar gets better and better this time of year. Enjoy your weekend.  

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