Since the start of September, markets have generally adopted a “risk-off” stance, driven by uncertainty in the labor market and shaky economic data. Investors seem to be catching their breath, taking profits, and tucking themselves into defensive plays.

From stocks to bonds and even commodities, the mood is less “go big” and more “let’s not lose what we’ve gained.”

As billionaire super-investor Warren Buffett once said: “Rule No 1: never lose money. Rule No 2: never forget rule No 1.”

It could also be that investors are simply hitting the pause button after a strong run, taking a breather and locking in some profits. Defensive moves are cropping up across the board in stocks, bonds, and commodities.

In the stock market, we’re seeing a shift toward safer bets. The S&P 500 has already experienced a modest dip this month, but consumer staples and utilities, the classic safe havens during slowdowns, have outperformed. Clearly, when the going gets tough, people still need soap and electricity.

Meanwhile, Treasury yields are retreating in response to softer labor market reports and the looming likelihood of Federal Reserve rate cuts. In a surprising twist, the yield curve (the difference between the 10-year and 2-year Treasury yields) has finally flipped positive after being in the red since mid-2022.

This kind of un-inversion usually signals that the Fed is about to lower rates, which tends to happen when the economy starts limping.

The benchmark 30-year U.S. Treasury yield also has taken a pronounced dip (see chart).

The 30-year yield currently hovers well below its 20-, 50- and 200-day moving averages.

With this cautious tone echoing through multiple asset classes, it seems that markets are treading carefully, perhaps wisely so.

But remember, we’ve had a few of these growth scares in recent months, only to see them evaporate as U.S. economic data proved more resilient than feared. When market sentiment gets too gloomy, the bar for positive surprises lowers, making it easier for good news to boost markets again.

A potential source of cheer? The Federal Reserve, of course. Rate cuts and dovish signals from the Fed should help revive market spirits.

The Fed has recently emphasized its focus on employment, with Jerome Powell even stating at the Jackson Hole symposium that he and his minions at the central bank aren’t looking for further cooling in the labor market.

Wall Street is betting that the Fed will slice rates by 0.25% at the September 17-18 meeting of the Federal Open Market Committee (FOMC), lowering the fed funds rate to 5.0%-5.25%.

If the economy takes a sharper turn for the worse before then, a larger cut—0.50%—might be on the table. However, the latest consumer price index (CPI) data, released Wednesday for the month of August, showed that inflation continues to cool. Stocks jumped higher as a result.

Government data on Thursday showed that wholesale prices rose in August roughly in line with estimates. The producer price index (PPI), a measure of final demand goods and services costs that producers receive, rose 0.2% on the month, matching the consensus estimate.

Excluding food and energy, the “core” PPI climbed 0.3%, slightly hotter than the 0.2% estimate. On an annualized basis, headline PPI rose 1.7%. Excluding food, energy and trade, the annual rate was 3.3%.

In other economic news Thursday, the Labor Department said initial filings for unemployment benefits totaled 230,000 for the week ended Sept. 7, up 2,000 from the previous period and higher than the 225,000 consensus projection.

Powell’s press conference next week should offer clues about the pace of future cuts, possibly hinting that bigger reductions might be on the horizon. Overall, investors expect the Fed to signal firm support for both employment and economic growth, which should provide a much-needed boost to market sentiment.

For those playing the long game, any dips are a good time to buy into market weakness, especially with lower interest rates on the horizon. Cheaper borrowing costs for consumers and businesses should eventually spur a fresh wave of economic growth.

I advise investors to stick with large- and mid-cap U.S. stocks and recommend diversification beyond mega-cap tech. Sectors like utilities and industrials are poised to benefit from a lower-rate environment and offer solid returns.

Finally, for investors who are sitting on a pile of cash in short-duration instruments like CDs or money market funds, beware of reinvestment risk. With rates likely to head lower, it would be wise to start gradually extending bond duration, particularly in investment-grade bonds, because rate cuts are likely to keep rolling in through 2024 and beyond.

On Thursday, the main U.S. stock market indices belied the seasonal “September Effect,” at least for the time being, and closed higher as follows:

• DJIA: +0.58%
• S&P 500: +0.75%
• NASDAQ: +1.00%
• Russell 2000: +1.22%

Inflation, as measured by both the CPI and PPI, is on a sustained downward slope. In addition, the jobs market continues to cool.

The upshot: a rate cut (probably on the magnitude of 0.25%) is still on its way.

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John Persinos is the editorial director of Investing Daily. You can reach John via mailbag@investingdaily.com

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