US stocks eke out smallest quarterly gain since pandemic

Newsletter: Unhedged

The US stock market eked out its smallest advance for a quarter since the pandemic knocked global financial markets last year, as investors confronted the reality that some of the main drivers of a long-running rally could soon peter out.

The blue-chip S&P 500 index of large companies ended the quarter up just 0.2 per cent — a far cry from the standard investors became used to during the rally over the past year and a half. Losses in September, when the index suffered its worst monthly performance since the nadir of the crisis last year, nearly dragged the S&P 500 into the red for the period.

Underscoring the weak performance was the fact that more than 260 companies in the index fell in value during the period, including heavyweights such as Amazon and Facebook.

The moves suggest investors are recognising that a major propellent of the rally could soon be removed: hundreds of billions of dollars worth of central bank stimulus each month that has helped prop up stock and bond prices. The Federal Reserve signalled after its most recent policy meeting last week that the economy was almost strong enough for it to begin scaling back its bond-buying programme and eventually lift interest rates.

“The game is going to work until it doesn’t and when it doesn’t . . . I foresee something very violent,” said Mike Lewis, the head of US equity cash trading at Barclays. “I could see a real equity market drawdown. You’ve had 14 years of global co-ordinated central bank accommodative behaviour.”

A growing list of concerns rattled investors as the quarter came to an end, with shifts from central banks across the globe that could presage tighter monetary policy sparking a sell-off in the bond market that ricocheted into the $50tn US stock market.

Shares of healthcare and financial services companies nonetheless delivered support, with lift for the S&P 500 provided by some of its largest constituents, including Tesla and Google parent Alphabet.

Line chart of performance since the start of 2020 (%) showing US stocks rise for the sixth consecutive quarter

But glimmers of how investors might behave in a world of tighter monetary policy were evident as the quarter came to an end. While small cap and transportation stocks that are more sensitive to economic growth ended the quarter lower, both began to dramatically outpace the tech-dominated S&P 500 in the final days of September.

The benchmark S&P 500 suffered its first monthly loss since January and its biggest decline since March 2020 when the pandemic rattled global financial markets.

“Markets have been holding in, but the strength has not been broad-based and there has been a rotation taking place below the headline returns,” said Ralph Bassett, head of North American equities at Abrdn, the $700bn asset manager.

Bar chart of Quarterly performance, by sector (%) showing The S&P 500 advance was led by gains in bank and healthcare stocks

Even amid mounting concerns, stocks have still largely remained the port of call for retail and institutional investors, with funds that buy US equities counting more than $40bn of inflows in the quarter, according to preliminary data from EPFR.

Market measures of volatility have perked up after trending lower from highs hit at the start of the year. The more turbulent trading has been propelled by fears of how a default of Chinese property developer Evergrande could ripple out, as well as how slowing economic growth will hit markets.

Bassett said the economy was fundamentally strong, but investors were grappling with how to balance the “tension between wanting exposure to growth, and rising interest rates and thus discount rates that could act as a headwind”.

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