Summary: US stocks ended September with their biggest monthly decline since last December 2022, with the S&P 500 and Dow dropping by 4.8% and 3.4%, respectively, while the technology-heavy Nasdaq lagged by losing 5.8%.   The expectation of "higher for longer" interest rates put pressure on markets. With a hawkish hold in September's FOMC meeting and hawkish commentary from several Fed policymakers, investors are worried that a pivot toward lower rates will not happen any time soon. The US long-term interest rates surged due to the uncertainty in the macro landscape. Also contributing to the negative sentiment was a series of modestly adverse events in the US, such as an escalation of the UAW strike, a looming government shutdown, and a recent upswing in oil prices. We continue to hold the view that the resilient economy and persistent inflation call for sustained restrictive monetary policy, which could lead to narrower profit margins, weakened balance sheets, and a mild economic slowdown. Given this backdrop, we have maintained a cautious approach to equities, reducing our US equity exposure to 40% and international exposure to 62% during the month. 

Valuation

• Valuation metrics for equity remained negative. P/E decreased from 22.1 at the end of August to 21.1 at the end of September.
• Forward P/E decreased to 19.9 at the end of September from 20.6 at the end of August.
• Inflation-adjusted valuation metrics continued to be negative.
• Equity valuation metrics relative to bonds remained negative with high bond yields.

Sentiment

• U.S. manufacturing activity contracted for the 10th consecutive month, with the ISM manufacturing index edging up 1.2 points to 47.6 in August.
• The University of Michigan Consumer Confidence Index fell again in September, dipping to 68.1, with rising gasoline prices and the declining equity market weighing on confidence.
• The NAHB index fell from 50 to 45 in September, below the neutral level. 

Technical

• Technical indicators were positive overall, with positive momentum and fear signals outweighing neutral reversal signals.
• The S&P 500 was 2% above its 200-day moving average, 2% below the 100-day average, and 4% below the 50-day average.
• The VIX index spiked after mid-month with market volatility, hitting its highest level since May before retreating and settling at 17.5 at the end of the month.    

Macroeconomic

• Nonfarm payrolls rose by 187,000 in August, slightly higher than consensus forecasts. The four-week moving average of initial jobless claims dropped to 211,000 as of Sep 23, the lowest level since February.
• Retail sales grew 0.6% in August after rising 0.5% in July, supported by a healthy labor market and real wage growth. 
• U.S. industrial production increased solidly by 0.4% in August. 

Fed – higher for longer: As widely expected, at its September meeting the FOMC chose to keep the fed funds rate unchanged at the range of 5.25% to 5.5%. At the same time, there were notable shifts in the FOMC's economic forecast in the September Summary of Economic Projections (SEP), driven by the resilient U.S. economy data in the summer. The SEP predicted higher real GDP growth for 2023 (from 1% in June to 2.1%) and 2024 (from 1.1% to 1.5%). The estimate for unemployment rates was also revised lower from 4.1% to 3.8% in 2023, and from 4.5% to 4.1% in both 2024 and 2025. Core inflation forecasts were trimmed from 3.9% to 3.7% for 2023, indicating that the FOMC believes that inflation can be controlled without a significant rise in unemployment. However, the FOMC's stance was generally viewed by the market as a hawkish pause as it maintains a bias toward tightening, with the dots (the Fed dot plot is a chart showing projections for the fed funds rate) for 2024 and 2025 moving 50bp higher. Also, 12 out of 19 participants have projected another hike by 2023 year-end, and participants have postponed their timeline for the first rate cut.

Surging yields weighed on markets: Bond yields are experiencing a significant upswing this month, putting pressure on the equity market. Due to a volatile macroeconomic environment, rising oil prices, and a substantial fiscal deficit, Treasury yields across various maturities reached their highest levels in over ten years. Specifically, the 10-year U.S. Treasury yield has surged to 16-year highs at 4.69%. While major central banks have paused rate hikes, they have left the possibility open for future hikes, which aligns with our long-held view that interest rates will likely remain high. We believe that the treasury markets are more reasonably priced after the recent rise in yields, as the increase in long-term bond yields indicates that markets are adapting to the heightened risks associated with the new era of amplified macroeconomic and market volatility. 

Oil prices: Crude oil prices have surged by approximately 30% since midyear. This rise is primarily attributed to a disruption in the oil supply, stemming from Saudi Arabia's coordinated decision with OPEC to reduce oil production in late June. This action set off a steady upward trend in energy prices. Additionally, there has been a notable rebound in demand from China, evidenced by recent production and refinery activity data in the country. The rising oil prices resulted in the fastest monthly rise in headline CPI in August since June 2022, largely driven by a 10.6% rise in gasoline prices. Furthermore, investors are concerned that the supply cuts may continue, possibly in conjunction with other relatively modest adverse events in the US, such as an escalation of the UAW strike, a potential government shutdown, and the recent increase in US long-term interest rates. Hence, we anticipate one more potential uptick in headline inflation next month, followed by a subsequent decline. Should this materialize, it increases the probability of an additional rate hike in 2023.