The S&P 500 moved back to new highs last week and gained in the month of August during a president’s second term for the first time since 1950. That’s the good news. The bad news is we aren’t out of the woods yet, as September is historically the worst month of the year and the odds of some volatility over the coming month or so are high. (But the calendar historically starts looking better in October.)
The Worst Month of the Year
First off, we’d like to stress this is still a major bull market and we expect higher prices from current levels before the end of the year. None the less, after an impressive four month win streak and 30% rally from the April lows, the calendar isn’t doing anyone any favors currently. That’s right, welcome to September.
Here’s a nice way to show how weak this month has been historically. It is the worst month since 1950, over the past 10 years, over the past 20 years, and the third worst in a post-election year. We would never invest blindly solely based on calendar effects, but it is better to know about them than not know. Of course, we noted a month ago that stocks usually do poorly in August (especially in a post-election year) and the market bucked the trend this year. That’s not completely unexpected—surprises to the upside are just more likely to happen in bull markets. The catalyst this time was Federal Reserve (Fed) Chair Jerome Powell’s dovish pivot in his speech at Jackson Hole on Friday, August 22.
Speaking of post-election years, August was higher this year, but did you know that August and September have both been higher only three times (out of 18) in post-election years since 1950? We aren’t saying stocks can’t move higher this September (it is a bull market after all), but the best way to approach it is to be prepared for some volatility.
Here’s a similar table as above, but it has the average returns this time. September is indeed the only month to be down on average in all four categories, with no other month down even in three.
Lastly, here is the same data as above, just shown another way to better visualize things. The bottom line: after a historic run, some turbulence this month would be perfectly normal, but with many other reasons to be positive about the outlook, we expect any weakness to be fairly well contained.
The Fed Has an Inflation Problem but They’re Going to Cut—That’s Bullish
In his August 22 speech at the Jackson Hole Symposium, Fed Chair Jerome Powell opened the door to a September interest rate cut Powell argued that while risks to inflation are tilted to the upside, risks to the labor market are tilted to the downside. But since policy rates are already in restrictive territory, the balance of risks means a cut may be warranted.
In our opinion that is a completely fair argument. At the same time, it looks like the Fed has a big inflation problem on its hands. We just got the latest (July) reading on the Personal Consumption Expenditures Price Index (PCE), which is the Fed’s preferred inflation metric.
- Headline PCE rose 0.2% in July. It’s running at a 2.6% annualized pace over the last three months and is up the same amount over the past year.
- Core PCE (ex food and energy) rose 0.26% in July—equivalent to 3.3% annualized. It’s running at a 3% annualized pace over the last three months and is up 2.9% over the past year (the fastest pace since April 2024).
In short, core inflation, which is what the Fed looks at, remains stubbornly high. And it looks to be moving in the wrong direction.
Now, a chunk of this is coming from the tariff-related impact on durable core goods like furnishings, appliances, and recreational goods. PCE for durable goods is now up 1.1% since last year and running at a 1.5% annualized pace over the last three months. These numbers don’t look too “hot” but the counter-factual (in the absence of tariffs) is that core goods prices would actually be falling, exerting a downward force on inflation, rather than pushing it higher.
Now you can argue that tariffs impacts are a one-off effect. It may not show up all at once (especially since tariff policy hasn’t settled to its final place yet), but any impact should pass sooner rather than later. In fact, Powell made this case in his Jackson Hole comments, and just this week, Fed governor Chris Waller (who is the current favorite to replace Powell as Chair next year) said he is “back on Team Transitory.” He thinks the recent upward move in inflation is temporary.
We’re in agreement that core goods inflation, as much as it’s coming from tariffs, is temporary. But the problem is that it’s not the only driver of elevated inflation right now. Case in point: In July the PCE index for durable goods actually fell 0.1%, and yet core PCE was up 0.26% (3.3% annualized). In other words, the inflation problem goes beyond goods. Services inflation is a problem, and that’s a harder one to solve. Up until last year, you could say that lagged housing inflation numbers were pushing up core services, but shelter inflation has normalized now. It also makes up a smaller portion of PCE than it does in the Consumer Price Index (CPI). PCE for core services excluding housing has been showing quite a bit of heat recently, and as you can see in the chart below, it’s running well above where it was pre-pandemic
- Core services excluding housing inflation rose 0.39% in July (equivalent to 4.7% annualized)
- Last 3 months (annualized): 3.0%
- Last 12 months: 3.3%
- 2018-2019 (annualized): 2.2%
Note that core services ex housing makes up over 50% of the PCE inflation basket—so it matters.
Here’s another way to look at it. We looked at 178 items that make up the core PCE basket and calculated the distribution of year-over-year inflation at four different times. You can see how inflation really broadened out in June 2022 relative to December 2019. Then it started narrowing again through to the end of last year. But things haven’t progressed since then, and in fact, look to be going in the wrong direction.
- In December 2019, 24% of items had inflation rates above 3%.
- In June 2022 (when inflation peaked), 72% of items had inflation rates above 3%.
- In December 2024, 40% of items had inflation rates above 3%.
- In July 2025, 45% of items had inflation rates above 3%.
We’re still a long way from where things were in 2019, and not moving in the right direction.
The big picture is that the Fed’s got an inflation problem and it’s coming from two sources, one not so worrying (and perhaps “transitory”) and one more worrying.
- PCE for durable goods is up 1.1% year over year (as of July), which is higher than anything we saw from 1996–2020. In fact, the average inflation rate for durable goods was -1.9%, i.e. prices headed lower and lower for 25 years.
- PCE for services is running at 3.6% year over year and is stuck at that elevated level, especially relative to the average of 2.5% from 1996–2020. (It averaged 2.9% from 1996–2008 and 2.1% from 2009–2020.)
A Lot of Cuts Are Being Priced In by Markets
As noted above, the downside risks to employment may warrant an insurance cut in September, if not another one in December. But here’s the thing: markets are pricing in a lot more cuts into 2026. The chart below plots expected short-term rates at the end of each year from 2025 to 2031 on three dates: end of last year (December 31, 2024), Liberation Day (April 2, 2025), and the current level.
Markets are currently pricing in a policy rate of under 3% by the end of 2026. Given the current policy rate of 4.4%, that implies six cuts (each worth 0.25%-points) over the next 16 months. That’s a lot more than what was expected at the end of last year, when markets expected the policy rate to land close to 4% at the end of 2026, implying just 2 cuts over the two years (2025–2026). Granted, we’ve seen the economy weaken since then, and expectations have fallen a lot. But even on Liberation Day, when recession odds were higher than they are now, markets expected the policy rate at the end of 2026 to be 3.4%, about 1%-point below where it is now (equivalent to 4 cuts).
All this to say, markets are now expecting a slew of rate cuts ahead, especially in 2026, even as recession odds have fallen (relative to April) and inflation remains a problem (and not just because of tariffs). Now, part of this may be because the market is pricing in a Fed that goes along with President Trump’s desire to lower interest rates—he wants to see them near 1% (implying a 3%-point cut from where the policy rate is now), which is extreme given the current environment, but even if you get half of that, it lands you at a policy rate of about 3%. And that’s exactly what markets are pricing in now. The green line in the chart does show that markets expect the Fed to start tightening policy again from 2028 onwards, but that’s well out in the future.
All this is pretty bullish for equities, as we’re seeing several things that markets tend to like: the likelihood of a very dovish Fed that is looking past elevated inflation; lower recession odds (just by way of lower rates, which may bring a boost in cyclical activity like housing); and deficits heading to about 7%-8% of GDP, which is good for profit growth.
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