The weakness in the stock market was widespread in the third quarter as investors acknowledged the likelihood of higher for longer interest rates.
The S&P 500 delivered total returns of negative 3.3% for the quarter, according to data from S&P Global Dow Jones Indices, with only communication services and an energy sector buoyed by climbing oil prices registering positive quarters.
Sticky inflation above the Federal Reserve's target means that rate cuts are likely to be further out than equity investors had hoped, which has led to a spike in bond yields. This is a bad sign for stocks as rising bond yields suggest higher rates and a weaker economy, both of which are negative for earnings and valuations.
"Chill winds of worry are swirling about high interest rates settling in and there is set to be little respite from the sell-off," said Susannah Streeter, head of money and markets at Hargreaves Lansdown.
Weak quarter, good year
Despite a weak quarter, the S&P 500 has still had a good year to date, returning 13.1%. The surge in AI-related stocks such as NVIDIA Corp. drove the S&P 500 Communication Services sector to a 40.4% total return between Dec. 30, 2022, and Sept. 29, 2023.
The information technology and consumer discretionary sectors have also performed strongly. The latter was aided by the presence of Amazon.com Inc., which enjoyed a 55.2% increase in its share price in the first half of the year. Amazon accounts for over 30% of the S&P 500 Consumer Discretionary Sector Index.
These sectors fared worse in the latest quarter, with tech returning negative 5.6% while the gains in the consumer discretionary sector were reduced to negative 4.8%.
Only communication services and the energy sector delivered positive returns for shareholders in the third quarter at 3.1% and 12.2%, respectively.
A strong rise in oil prices bolstered energy producers as Saudi Arabia and Russia, two major exporters, decided to reduce output. The NYMEX crude oil price rose 28.5% during the third quarter from its June 30 close. This was good news for Exxon Mobil Corp. and Chevron Corp., the two largest constituents in the energy index, which enjoyed share price rises of 9.6% and 7.2%, respectively.
Looking ahead
The yield on 10-year Treasurys jumped to 4.81% from 4.59% in the first days of October before settling to 4.73% on Oct. 4, driven by market expectations about tightness in the labor market and the prospect of further rate hikes by the Federal Reserve.
"It feels gloomy right now with a 'higher rates for longer' assumption helping to sour sentiment," said Russ Mould, investment director at AJ Bell. "This is reflected in the sell-off in bonds — with US government bond yields hitting levels last seen in 2007, not a year with particularly happy memories for investors."
Yet new US jobs data from Oct. 4 suggested the labor market is cooling down and that the Fed is near the end of raising rates. The S&P 500 ended the day up 0.8%.
Employment data provided by the ADP Research Institute — an arm of employer services company ADP Inc. — showed private employers added 89,000 jobs in September, the weakest number since January 2021.
The US Labor Department on Oct. 6 will release its own report on the job market in September. Economists expect the government data to show 160,000 new jobs in September, down from August's gain of 187,000, according to estimates compiled by Econoday.
While this may be encouraging for investors looking for signs that rate hiking will end, more data is needed to confirm the direction of travel.
"ADP data has been rather poor of late and has been subject to wild revisions. In fact, even the official jobs data has also been continually revised. Investors appear reluctant to trust these numbers, and rightly so," said Fawad Razaqzada, market analyst at StoneX.