September weakness: a buying chance, not a warning
September usually brings higher volatility and lower returns. Choppiness started in September and through the back half of August, yet the market sits only a couple percentage points off all-time highs, so volatility has stayed low. Positioning confirms this calm: the VIX remains low, put-call ratios show little demand for downside protection, and overall positioning is still overweight. People know September is a headwind, but they are not positioned for it. That gap means more volatility could still hit through the rest of the month. Call demand suggests bulls remain in control and expect the market to shake off the weakness.
Breadth is weakening under the surface
One of the best breadth measures is the percentage of names trading above their 50-day moving average. At the start of August that reading was 70%. It is now 47%, a sharp drop in a couple of weeks. The market held up over the past month because the largest weights - the top names in the index - kept holding, while stocks underneath deteriorated. This is not a sign of imminent collapse. It means the foundation is more fragile. Negative news, a further surge in oil, or a Fed rate hike could set off the volatility that typically comes with September.
Bonds: 4.8% points toward 5%
The 10-year yield sits at 4.81%, a new year-to-date high. Breaking above 4.8% suggests the next stop is 5%. Higher rates have been pressuring equities for the past year, but strong earnings hid the pain. The 10-year low last October lined up with the peak S&P 500 (SPX) valuation of about 23 times. As the 10-year rose from below 4% to 4.80%, the S&P 500 valuation fell from 23 times to under 19.5 times today. The market is still up only because earnings have been very strong.
The open question is how much more upside remains for 2027 earnings estimates, given how much they have already climbed. Barclays (BCS) raised its year-end target to 8,100. Reaching 8,000 on the S&P 500 is very possible just by holding today's valuation flat and rolling forward to the 2027 earnings estimate of $416 a share, which is up over 17% year to date. That earnings jump is a main reason for the market's lift. Holding the valuation, though, likely needs relief on rates. If rates keep rising, they put downward pressure on the valuation and make 8,000 harder to reach.
Oil and inflation risk
Brent crude is above $100 a barrel; WTI is above $95, approaching $96. The war with Iran is escalating, not calming, with an exchange of strikes. Add China: for the seven months since the war started, China pressured oil prices lower, but recent reports show China started buying oil again instead of just drawing down inventories. China still holds plenty of oil and is nowhere near tank bottoms, yet renewed Chinese buying could push oil prices higher.
Even with oil off its yearly highs, diesel prices are at new year highs, and diesel feeds into goods prices and inflation. The average gasoline price was higher in August than in July, which points to faster month-over-month headline inflation. The Fed's question is whether there is enough good news under the surface on core inflation. Waller has said the Fed is watching core inflation; if it decelerates, some members could argue for holding rather than hiking.
The Fed: does everything hinge on CPI?
For the September rate hike, yes. Fed members have signaled that a hotter core CPI print would give them the reason to move. The Fed targets PCE, but CPI and PPI filter into that reading. The market now prices a two-thirds chance of a hike, and that could swing on the data due Thursday and Friday.
The path has whipsawed: it was a coin flip, then the last CPI print pushed expectations toward no hike, then Fed head Kevin Warsh spoke and hike odds rose, then expectations backpedaled ahead of the jobs report. The jobs report came in much stronger than expected, moving the market back to a two-thirds chance of a hike.
Watch the 2-year yield closely. October is off the table because it falls right before the midterms, so a hike would come in September or December. The 2-year yield is about 65 basis points above the Fed funds rate, meaning the bond market believes the Fed has a hiking bias. The 2-year keeps trending up, pricing in more hikes, because the bond market sees inflation running hot, growth in the mid to high single digits, and financial conditions that are loose, easy, and stimulative - all of which could push the Fed toward more hikes. Whether the hike lands in September or December may matter less than that 2-year forward outlook.
