Exhibit 1 traces the performance of the FT Wilshire 5000 index. The -4.8% return in September was the largest monthly decline this year and it produced a negative return of -3.3% for Q3. It can also be seen that the market started to lose momentum from late July.
Exhibit 1: The performance of the FT Wilshire 5000 index
Source: Wilshire Indexes. Data as of September 29, 2023
The key catalysts behind the reversal in sentiment - higher for longer rate projections
Following Fed Chair Powell's Jackson Hole hawkish speech markets have been recalibrating interest expectations. Consequently, year-end 2024 interest rates are now expected to remain elevated with little scope for sequential cuts being priced in.
The second order effect of the move to 'higher for longer' projections has been a rapid rise in bond yields and the dollar…
Exhibit 2 shows move in both the US 10-year treasury (left) and the DXY $ index(right). We highlight that the bond yield has not only clearly broken out of a 30-year downtrend but probably needs to test the 2006 support level of c. 5%.
Exhibit 2: The move to 'higher for longer' has seen both bond yields and the $ rise.
Source: Refinitiv, FactSet. Data as of September 29, 2023
Rising yields + a rising dollar = tightening Financial Conditions
Financial Conditions apply a holistic view to the combined impact changes in the monetary policy cycle, credit cycle and currency have on both the economy, corporations, and risk appetite.
We have been pointing out for several weeks that the US Financial Conditions have moved back to highly restrictive territory primarily driven by contributions from interest expectations, real money supply, the status of the neutral rate, bond yields, lending standards and the dollar.
The problem is that tight Financial Conditions regimes tend to produce lower subsequent market returns
Exhibit 3 compares the returns delivered in the subsequent 12 months after both restrictive and accommodative Financial Conditions regimes. When markets face the headwind of restrictive Financial Conditions, the average return is about one-third of the level delivered when Financial Conditions are accommodative.
Higher for Longer Financial Conditions imply lower for longer subsequent market returns
Exhibit 3: Median FT Wilshire 5000 subsequent 12m returns under different Financial Conditions regimes
Source: Wilshire Indexes. Data as of September 29, 2023
