If I could teach you only one thing about investing, it would be that interest rates carry a lot of weight and expectations can be everything. OK, that’s two things. But they are related, because expectations of interest rates carry even more weight. 

It’s been a rough market for the past few days. The S&P 500 is down about -5% from August 25 through August 30. And most things you’ll read will blame JPow’s speech on the 25th. Is that 100% of the reason for the drop in stock values?

I say no. Here’s why.

First, ok it is certainly a reason.He wasn’t dovish – and it was the shortest speech he has given at the conference in three years (by quite a bit). Straight and to the point, he and his board members are focused on fighting inflation and will continue until it is close to their 2% target (but I think there is leeway here), regardless of what happens to growth or jobs. I would go so far as to say he even intimated a mild recession would be A-OK. BUT, IMO, he was not much more hawkish than he’s been recently or any more hawkish than speeches from the governors leading up to this have been.

And you know what? Market-based Fed interest rate hiking assumptions haven’t changed very much since Friday, while Treasury yields have also not changed much.

But something bigger is brewing that got a little less fanfare in terms of blame...and it goes back to oil/energy. Around the same time as Powell’s speech, two other data points/news came out.

1. A Reuters article published around 9 a.m. ET on the day of J. Powell’s speech said “some” officials at the European Central Bank want to “discuss” a 75bp rate hike at the upcoming September 8 meeting given worsening inflation trends. A similar headline came out later that day, reporting that “some'' in Europe want to have quantitative tightening talks this year. This is a big deal because Europe has barely raised rates this year, unlike the US Fed. They are behind the curve and also ground zero for the conflict between energy and Russia vs. Ukraine, impacting inflation.

2. Also on Friday, the current European Council president called for an emergency meeting of energy ministers to discuss the gas crisis. Under Putin’s leadership, Russia is escalating their strategy of squeezing Europe (and the US) by withholding energy and driving inflation higher until the flow of weapons into Ukraine stops. So far, there is no sign of Washington, or European leaders losing their will to support Ukraine, however.

More generally though, I see the four forces of negativity we have had throughout this year as the main reasons for the pullback in the markets. Three of them are 1) China’s COVID policy, 2) the conflict between Russia/Ukraine, and 3) inflation/interest rate hikes. From a fundamental perspective, valuations were also generally too high given expectations of earnings and interest rates. These three forces have been here, even if the market made it seem like they took PTO in July and early August. 

And the fourth force, sentiment, is now down again. It seems optimism has once again this year been snuffed out with the recent market action – similar to back in June. This may be especially true as we head into the seasonally weak month of September. Looking back over the last 20 years, the average stock market return in the month of September is -0.5% versus the average monthly return of 0.9%. (We also noted that this can be exacerbated in a midterm election year, like this year).

That being said, it’s no guarantee that markets will be down in September. But knowing this seasonality can be a valuable flag that can set expectations. Volatility and occasional downcycles in markets are actually pretty standard. As soon as you can expect it and plan for it (like understanding your time horizon, investing the right amount, diversifying, dollar cost averaging and other tools amongst these). You can potentially get through it to the other side and work towards building long-term wealth.

Back to DJ Pow though: let’s say his set on Friday was the sole catalyst for the market’s drop. Then the markets likely let hope overshadow the deeply ingrained saying: Don’t fight the Fed. Even though the Fed has shown us who they are and their intentions.  

As Maya Angelou once said, “When someone shows you who they are, believe them the first time.”

Source: Bloomberg, Robinhood