Markets Get A Dose Of Volatility

Summary

• All the major US indexes declined in September, but the tech-heavy Nasdaq Composite fell the most (-5.3%), highlighting the rotation away from tech and growth.
• Around the globe, developed and emerging markets both lost ground in September, but emerging market stocks took the bigger hit.
• Bond prices move inversely to yields, and last month’s yield spike resulted in another negative month for fixed income investments.

Elena Perova/iStock via Getty Images

Last month, stocks did what they've often done in September - decline. In addition to possible seasonal weakness, some of the risk factors that many investors appeared to shrug off the past few months conspired to hand the US market its second-biggest setback of the year.

Stocks retreated as Chinese economic weakness, Fed tapering news, rising interest rates, and a debt ceiling stand-off all captured headlines at different points throughout September. Also, rotation was in the air late in the month as investors sold growth stocks, including many market-leading "mega-tech" names that tend to underperform when interest rates rise, further pressuring the broad market.

Before reviewing what investors may want to keep tabs on heading into the fourth quarter, here's a look at the ground the markets covered last month.

US equities

All the major US indexes declined in September, but the tech-heavy Nasdaq Composite fell the most (-5.3%), highlighting the rotation away from tech and growth. The small-cap Russell 2000 followed through on its late-August relative strength to post the smallest loss (-3%) for the month:

Source: FactSet Research Systems

Sectors

Given energy companies tend to make more money when oil prices are high, crude oil's rally to a three-year high helped the energy sector (+9.4%) withstand September's red tide:

Source: FactSet Research Systems

International equities

Around the globe, developed and emerging markets both lost ground in September, but emerging market stocks took the bigger hit. The MSCI Emerging Markets (EM) index fell 4%, while the MSCI EAFE index of developed markets lost 2.9%:

Source: FactSet Research Systems

Fixed income

Bond prices move inversely to yields, and last month's yield spike resulted in another negative month for fixed income investments. Also, for the second-straight month, high-yield corporate bonds were the best fixed income performers in the US. The benchmark 10-year T-note yield posted its third-biggest monthly increase of the past three years, closing September at 1.52%, up from 1.3% at the end of August:

Source: FactSet Research Systems

Looking ahead

September's dominant themes aren't likely to disappear overnight, but it's important to keep them in perspective and maintain a long-term outlook. A few things to keep in mind as markets push into Q4:

• Rising rates. While rising longer-term interest rates generally reflect optimism about economic growth, the stock market's reaction to last month's yield spike highlighted its vulnerability to any upsetting of the apple cart. The 10-year yield pushed above 1.5%, still very low historically, but significantly higher than it was just weeks ago. And, with oil prices near three-year highs, that means two of the basic inputs to the economic process - borrowing costs and energy - are more expensive.
• Inflation and the consumer. Morgan Stanley analysts recently highlighted the pressure these rising costs could put on corporate profit margins. But when things are more expensive for companies, they tend to get pricier for consumers, too. Toward the end of last month, Fed Chairman Jerome Powell acknowledged inflation was already more significant and longer-lasting than expected. The question now is whether people will maintain their appetite for spending as companies pass on their increased costs to consumers.
• China. The economic slowdown in China - the country that has provided significant tailwinds for the global economy for the past 18 to 20 months - may put more pressure on other major economies to pick up the slack and continue to provide the fuel for further stock gains.

A glass half empty? Not necessarily. Risk is always present, but it's important to understand the nature of the different challenges the market faces at any particular moment in time - many of which are often temporary. For example, Washington has always found a way to resolve its debt-ceiling debates, although in the current era of heightened partisanship, it's certainly possible that this time a deal won't be struck until the last minute. For investors, diversification and a long-term perspective remain the foundation of a portfolio equipped to ride out unpredictable markets.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.