What’s New

As the seasons start to change, so too has the market backdrop. For the first time in over a year, the Federal Reserve (Fed) cut interest rates when they lowered their benchmark rate by 0.50% on September 18th. In doing so, the longest pause after a rate hiking cycle in the Fed's history concluded.

Sovereign yields continued to move generally lower into the announcement, with the short end falling faster than the long end – and the yield curve continuing to steepen as it came out of inversion early in the month. Since then, the curve has continued to steepen. However, it does appear that rates may have found a temporary bottom post-cut. As for equities? They're continuing to make new all-time highs since mid-September, led by information technology, communication services, materials, consumer discretionary, and utilities.

Where we go from here is now largely dependent upon the trajectory of the economy. History shows that average 12-month forward returns tend to be negative when rate cuts are followed by a recession. Meanwhile, rate cuts without a recession see markets continue to move higher. This is intuitive, as the Fed cutting into a recession is likely to see a downdraft in earnings and sentiment. Comparative to rate cuts in a non-recessionary environment which can lead to multiple expansion and easier credit conditions, supporting stronger growth and risk appetite.

On that front, the jury is still out. Economic data continues to paint a picture of a resilient US economy, buoyed by a resilient US consumer. While labor markets are softening, more real-time data like initial claims continue to send a largely benign signal. We see risks to both the upside and the downside from here and will be closely monitoring to see how things develop in the coming months. What’s interesting now, though, is that those divergent views are showing up in markets. While equities continue to make new all-time highs, the bond market is pricing in nearly 2.00% of cuts by the end of next year. This type of cutting cycle would likely require a much weaker economic backdrop to materialize, a counter to the signal currently being sent by equities. It feels like something has to give.

Also of note during the month was the material change we saw in Chinese policy. There’s no doubt that this contributed at least in part to the performance of the Materials sector and helped to put a floor under yields. With policymakers taking fairly significant steps to put a floor under the property market and support Chinese equities, the latter rallied aggressively, finishing the month up over 20% from the lows in mid-September. To the extent that there is follow-through on the fiscal front, the shift in policy has the potential to be a tailwind to global growth. At the very least, it is possible that the headwind from China could be ebbing.

Our Perspective

As we move into October, we believe that risks continue to remain balanced. Markets once again seem to be characterized by a degree of complacency that can quickly yield to volatility. This is set against a backdrop of softer (albeit resilient) US labor market, elevated valuations, what we view as overly aggressive expectations of cuts from the Fed, and elevated geopolitical tensions. We believe that our active approach to investment management will continue to allow us to uncover investment opportunities, while largely avoiding parts of the market where we see elevated risks moving forward.

We have been concerned about the downside risks to the US economy for some time now. While we continue to see signs of softening in the US economy, growth has remained incredibly resilient due in large part to the massive fiscal transfers undertaken in the months and years following the pandemic.

We believe that we are now nearing a critical juncture; fiscal stimulus has mostly moved through the system and unemployment is rising. With the Federal Reserve having cut rates after its longest post-hike pause in history, we are closely monitoring for signs that the much-needed normalization in the economy does not turn into something worse. Given the varied risks we see in the market today, we are placing an emphasis on risk management and have adopted a modestly defensive position in our core portfolios.

Our View

Economic Cycle		The US economy has remained resilient despite the aggressive hiking cycle we saw from the Federal Reserve. However, we did see pain in industries including transport and manufacturing. The US consumer has remained strong. We believe that the lagged effect of monetary policy could start to be felt in other parts of the economy in the coming quarters, and we are keeping a close eye on the labor market.
Stock Market		The US stock market continues to trade near all-time highs. Sentiment now appears stretched and valuations are not compelling. To date, market returns have been driven by multiple expansion. EBIT margins climbed to historical highs in the years following COVID lockdowns; elevated input costs and weakening demand and pricing power are posing a risk to the ability of corporations to maintain earnings at their projected level. Returns will be harder to come by and stock selection will be increasingly important.
Bond Market		While growth has remained resilient and inflation remains above target, interest rates have come in off of their peak as the market has started pricing in rate cuts from the Fed. Corporate spreads remain well contained, particularly considering the risks we see to the economy.
Important Issues on the Radar		Inflation: After surprising to the upside to start the year, inflation has resumed its downward trajectory. However, we would caution that we are still well above target and upside risks remain.
		China’s Economy: China has pivoted on key economic issues that acted as severe headwinds to growth over the last two years; however, economic growth appears to be stagnating and it will be critical to monitor the magnitude and the effectiveness of the policy response in the coming months.

Indicates change Indicates no change

Source: Bloomberg.

All investments contain risk and may lose value. This material contains the opinions of Manning & Napier, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

This newsletter may contain factual business information concerning Manning & Napier, Inc. and is not intended for the use of investors or potential investors in Manning & Napier, Inc. It is not an offer to sell securities and it is not soliciting an offer to buy any securities of Manning & Napier, Inc.