Highlights:
- Market attention in September centered on the Fed’s quarter-point rate cut and prospects for more easing, overshadowing concerns about a possible government shutdown.
- The S&P 500 advanced 3.6% in September and 8.1% in Q3, with year-to-date gains reaching 14.8%. Both large and small indices hit record highs during the month.
- Smaller stocks surged on expectations of reduced borrowing costs. Technology and Communications sectors led the market advance, while defensive sectors Consumer Staples and Health Care lagged.
- Despite trade tensions, inflation concerns, and labor market weakness, markets rebounded quickly, with investors largely dismissing shutdown fears given strong performance during past episodes.
The forward-looking stock market had its eye on two main factors in September: the increasing likelihood of a government shutdown and the Federal Reserve’s interest rate policy. The Federal Reserve piece proved to be the more compelling as the Fed cut rates by a quarter point on September 17, with a consensus that more cuts would be imminent. The S&P 500 Index rose 3.6% over the month, bringing the year-to-date return to 14.8%. It was also a strong third quarter, with the S&P up 8.1%. The month saw new all-time highs for both large and small indices.
The September focus on lower rates was particularly evident in smaller stocks, where low-to-no-profit firms surged, buoyed by the prospect of decreasing borrowing costs. Among larger stocks, it was the now familiar story of megacaps, with the Technology and Communication Service sectors leading the market advance. Conversely, traditionally defensive areas were weak with Consumer Staples and Health Care lagging the index return.
One of the most notable aspects of the stock market this year has been its advance in the face of considerable disruption from Washington. While tariff announcements and the ensuing fear of trade wars have roiled the market, we've witnessed quick rebounds. Investors have also seemed indifferent to a government shutdown, perhaps because stocks and bonds have performed well during past episodes. The market has also risen despite signs of persistent inflation and enough weakening in the labor market to shift Federal Reserve policy.
The market's reaction to the September rate cut is not really a response to any great impact a single quarter-point cut makes, but rather to the trend. We agree that more rate cuts are likely ahead, although the four anticipated through 2026 may prove to be overly aggressive. Still, the trend line for weakening employment, the driving force for future cuts, seems well established. Chairman Powell has made it clear that he sees tariff-induced inflation as a one-shot price boost and, as such, is willing to look past the current levels, which are well above the Fed's 2% target.
At month-end, we witnessed a different sort of market impact from Washington as President Trump and Pfizer announced TrumpRX, a plan to reduce consumer drug prices by providing consumers a more direct link to brand-name pharmaceuticals. While this project is still undergoing scrutiny, it immediately lifted the fortunes of many health care companies in a sector that has been the weakest in the S&P so far this year.
As we look ahead, we see positives in the resilience of consumer spending and corporate earnings. Fed rate cuts are a powerful force that could keep this three-year bull market on track for some time. On the other hand, the government shutdown, along with capricious policy announcements from the White House, demonstrates the potential for political complications. Add geopolitical risk and stretched stock valuation to remind us that risk management is most important at times when the market has seemed to cast it aside.