Macro Sell-offs And Market Seasonality

When interest rates and currencies move too fast, equity markets stumble.  Is it a harbinger of something bad?  Read on.

Japan
​For the past three decades, The Bank of Japan (BOJ) has kept its interest rates low by buying its own bonds.  They were desperate for higher growth and higher inflation.  In 2Q, Japan had strong growth.  With signs of rising inflation, the BOJ has shown a decreasing appetite to control rates.  As a result, the Japanese 10-year increased from 0.35 to 0.65% (red arrow in Chart 1).  This pushed up rates for all developed economies.  Markets are inter-connected.

Chart 1 - Japan 10 Year Yield

Source - Bianco Research

Weak China and the Dollar
After the initial re-opening bump, the Chinese economy has continued to weaken.  While the Chinese authorities are slowly adding monetary stimulus - it is measured - and so far seems inadequate.  Markets are asking for bold actions.  Foreign private investment is leaving China, and reports of real estate default are adding to the cautious sentiment.  Global caution helps the U.S. dollar.  The U.S. is also one of the clear beneficiaries of capital flight out of China.  To buy U.S. assets, investors have to buy dollars first.  This leads to a rising U.S. Dollar.  In the short term, a strong dollar is a risk-off signal which brings more selling.  

Chart 2 - S&P 500 & the Dollar

Source - Latticework Investments

​Strong U.S. Growth
While China is sputtering, the U.S. economy is accelerating.  Contrary to all expectations, the U.S. economy is growing >3% in 3Q.  The 10-year average is 2%.  Strong consumption and deficit spending are pushing up U.S. interest rates. The US 10-year rate is close to 4.3%.  Rising interest rates, if supported by better growth, isn't a negative by itself.  However, high rates are making home and auto purchases less unaffordable.

Strong Earnings
2Q earnings were 8% better than expected (chart 3) and above the 5% median surprise of the past 15 years.  Sales were 1.5% above expectations.  Improving real incomes (wages growing faster than inflation) is translating into improving retail sales.  Most large retailers have reported sequentially improving sales from May into August.  After a tough 2022, earnings momentum is building.  Historically, once earnings momentum builds, its lasts longer than a quarter.

Chart 3 - S&P Earnings Surprise

Source - Morgan Stanley

Seasonal Movements
Over the last ten pre-election years, the S&P has corrected in August, for different reasons.  In each case, the sellers have come back into the market only to buy back at higher prices (chart 4).  With healthy levels of skepticism regarding the future, will 2023 repeat the historical pattern?  
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Stay tuned.

Chart 4 - S&P Pre-Election Year Seasonality

Source - Oppenheimer