Stock market outlook for September 2023

The U.S. stock market fell in August, marking only the second month of declines as this year’s rally briefly lost some of its gusto. Stock prices took a big hit after Fitch, a ratings agency, downgraded the credit rating on U.S. debt, though the market bounced back amid more optimism that the Federal Reserve will pause on hiking interest rates.

The major benchmarks for the U.S. stock market all experienced a turnaround in August, though not enough to eke out gains. The Dow Jones Industrial Average led declines, falling 2.4%, while the Nasdaq Composite Index lost 2.2%, and the S&P 500 was down 1.8%.

Perhaps counterintuitively, that late-month rally in the stock market was spurred by signs of cooling in the U.S. economy. Although Fed Chair Jerome Powell warned in late August that further interest rate hikes could be necessary to fight inflation, market participants appear to be far less convinced. Traders now expect, with a greater-than 60% probability, that central bankers won’t raise rates again at any of the Fed’s final three meetings this year.

One of those meetings occurs this month, and while the central bank continues to dominate the market narrative, September could mark a “big pivot” if traders continue to brush off the Fed’s messaging about interest-rate policy, says Greg Bassuk, chief executive officer of AXS Investments. That doesn’t mean the Fed obsession immediately abates, but rather that traders will be more confident “we’re at the tail-end of the rate-hike cycle.”

Leading up to the Fed’s meeting, scheduled for Sept. 19 and 20, market participants will be especially keyed in on economic reports related to employment and inflation for signs that a rate-hike pause is in order this month. More broadly, the stock market faces a test of whether it can recoup August’s losses. 

Here’s what to watch in the month ahead, and how to invest in September and beyond.

The Federal Reserve has dominated the market’s attention since mid-2022, when central bankers embarked on their aggressive rate-hiking strategy to combat decades-high inflation. “The Fed seems to be controlling absolutely everything,” says Sandy Villere, partner and portfolio manager at Villere & Co. 

During his remarks at an annual economic symposium in Jackson Hole, WY, Powell reiterated that policymakers remain focused on getting inflation back to a goal of 2%. The Fed’s preferred measure of inflation, the personal consumption expenditures (PCE) price index, rose at an annual rate of 3.3% in July. Figures for August won’t be released until Sept. 29, though another inflation gauge — the consumer price index (CPI) — will be released on Sept. 13.

Ahead of the Fed’s mid-month meeting, expect that CPI report to be closely-watched, Villere says. “Inflation data is going to be quite important since it’s such a data-driven decision.”

Still, barring a report that shows “extremely” high inflation, a new tone may be struck in the market starting in September, Bassuk adds. As investors become more confident that a soft landing is possible, and the economy will avoid a recession altogether, they’ll also look for confirmation in reports that track consumer spending and the housing sector, he says.

What’s more, the employment report for August showed that hiring remains steady, though the unemployment rate rose to 3.8%, the highest level since early 2022. That report further emboldens those people in the market who hope the Fed will hold rates steady, and some slowing in the economy is deemed good news for stock prices.

Given that seemingly not-great news about the economy is deemed good news for stock prices, the stock market itself bears watching. Coming off the worst month of the year so far, stocks now enter what’s historically been a weak period. The S&P 500 has seen average declines of 1.1% in the 90-plus Septembers dating back to 1928, making this the worst month of the year.

Be it in September or not, some investors will be keen to see whether the S&P 500 can top its year-to-date high, set in late July, as this may indicate there’s more room for stock prices to rally But investors should brace for volatility as there will likely be “more bumps” in the road through the end of the year, Bassuk advises.

The source of such volatility for the U.S. stock market could come from afar, as geopolitical developments have been a bit ignored this year, Bassuk notes. The economic slowdown in China and the ongoing Russia-Ukraine conflict have the potential to “shake’ markets, he adds.

Another dynamic worth watching is whether investors continue to favor growth stocks in lieu of value stocks through the end of 2023, Villere notes. Growth stocks, or shares of companies that tend to grow faster than the broader market, have “come roaring back this year,” and one gauge is up more than 36% this year, he notes. By comparison, a gauge for value stocks — or shares of companies that may be inexpensive relative to their intrinsic worth — has risen less than 4%. 

The strong year-to-date returns for growth stocks like those in the technology sector might present a selling opportunity, especially for investors who want to buy stocks that have been “left for dead” in this year’s rally, Villere notes. People may find some “really, really cheap” stocks, particularly in sectors that have fallen out of favor more broadly — including financial services, consumer discretionary, and materials, he adds.

Another out-of-favor investment that Bassuk favors is real estate, and that’s because investments in this sector — including real estate investment trusts (REITs) — offer a combination of an income and growth opportunity. And commercial real estate is more attractive than residential because it has been “disproportionately hit hardest,” he adds.

Similarly, focusing on diversification — and even beyond stocks — may help investors to better weather market volatility, and that’s why Bassuk recommends that investors consider adding exposure in their portfolio to commodities and alternative investments. Because these assets aren’t so correlated to the performance of the broader stock and bond markets, “they allow you to stay invested” while mitigating some potential volatility in your portfolio, he adds.

Even if there is volatility, investors who feel cautious have more alternatives for earning solid returns, which is an about-face from last year’s so-called TINA dynamic, or there is no alternative. Some of Villere’s clients ask why they should invest in higher-risk assets when they can earn a 5%-plus on cash in their high-yield savings or money market accounts — and that logic is very rational, he says. 

“Now there are reasonable alternatives to stocks,” he says, adding that it may make sense for investors to keep up 10% to 15% of their assets in cash accounts. 

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This article was originally published on SFGate.com and reviewed by Lauren Williamson, who serves as Financial and Home Services Editor for the Hearst E-Commerce team. Email her at [email protected].