Wall Street Review: Small Caps Lead Broad Market Losses

Wall Street ended the week with broad losses amid a wave of negative headlines, from soaring oil prices and bond yields to trade tensions, elevated inflation, and an interest rate hike by the European Central Bank (ECB), all of which weighed on investor sentiment. Traders are now betting on a Federal Reserve interest rate hike next week.

Interest-rate-sensitive stocks, such as small caps, were hit the hardest. Semiconductor shares were the bright spot in bargain hunting after the profit-taking of the previous weeks.

Stocks rallied Friday as oil prices retreated and bond yields stabilized, but the gains weren’t enough to erase the week’s losses.

The Dow Jones Industrial Average closed at 52,573, up 0.98 percent on the day but down 2.07 percent for the week. The S&P 500 increased 0.86 percent to finish at 7,656 but was still down 1.17 percent for the week. The Nasdaq Composite gained 0.96 percent, ending the week down 0.94 percent. The Russell 2000, hit hardest by the week’s swings in rate expectations, added just 0.42 percent and remained down 2.17 percent for the week.

The CBOE Volatility Index, meanwhile, spiked 9.02 percent for the week to 15.84—a sign that fear is creeping back into markets.

Friday’s stock rebound came despite a fresh reminder that inflation isn’t fading. The headline consumer price index rose 0.4 percent in August—up from 0.1 percent in July and in line with forecasts—the largest monthly gain in three months, driven mainly by a 3.9 percent jump in gasoline prices.

The core price index, which strips out food and energy, rose 0.3 percent, the most since April and above economists’ forecast of 0.2 percent.

Mike Castle, senior commodities economist at StoneX, said that although the core consumer inflation reading was higher than the previous month, the annual increase of 2.4 percent matched the market expectation and was the lowest level since March 2021.

“This is a significantly better result than yesterday’s producer level inflation data, which should ease some of the most hawkish concerns and allow for a near-term sigh of relief on Wall Street,” he said in a company post before the market opened.

Rate Hike Expected

“Friday’s CPI print was in line with expectations, but inflation is still too hot, and the Federal Reserve’s hands are tied. A rate hike next week is all but assured,” Skyler Weinand, chief investment officer of Dallas-based Regan Capital, told The Epoch Times.

Weinand expects several more rate hikes in the months ahead as the Federal Reserve works to bring short-term rates in line with market pricing.

He said that despite a volatile labor market, job growth remained strong and employment was at a level the central bank would consider full.

“Immigration policy has reset the market expectations on what is normal, and AI innovation has yet to have any meaningful impact on jobs. We should expect this strong labor market trend to continue, absent an exogenous shock,” he added.

The path to next week’s decision ran through a volatile stretch for oil and bonds. Brent crude surged past $105 a barrel on Thursday—its highest since May 19—as fighting in the Middle East stoked fears of a prolonged disruption to regional energy supplies.

The 10-year Treasury yield edged toward the psychologically significant 5 percent level on Friday, while the 2-year yield climbed to 4.59 percent, up 0.14 percentage points during the session.

Wholesale inflation added to the pressure. The producer price index, released on Thursday, rose 0.4 percent in August, matching forecasts, after an upwardly revised 0.1 percent gain in July—the sharpest monthly increase in three months, driven by a 1.1 percent jump in goods prices and a 24.1 percent spike in diesel fuel.

Overseas, the ECB added to the global tightening bias. Its Governing Council raised its three key policy rates by 25 basis points on Thursday, citing the Middle East conflict as a continuing source of inflationary pressure.

Inflation’s persistence at both the producer and consumer levels, amid strong job growth, has strengthened the odds of an interest rate hike next week, when the Federal Open Market Committee holds its regular meeting.

As of Friday, the CME Group FedWatch tool assigned an 86.5 percent probability to a 25-basis-point rate hike, up from 59.4 percent a week earlier.

Looking Ahead

While a rate hike is not yet certain, Bret Kenwell, U.S. investment analyst at eToro, said that if the Federal Reserve does raise rates next week, its messaging will matter more than the move itself.

“If the Fed presents the move as insurance against renewed inflation rather than the beginning of a prolonged hiking cycle, markets could interpret it as a ‘dovish hike.’ That could limit further upward pressure on longer-term Treasury yields, even while short-term yields remain elevated,” he told The Epoch Times.

Rate-sensitive small-cap stocks bore the brunt of the selling all week. The Russell 2000 fell 1.32 percent on Wednesday as the 10-year Treasury yield rose toward 4.85 percent, then dropped another 1.04 percent on Thursday as the ECB’s move rippled through equity markets.

Earlier in the week, Brent crude’s climb toward $99 a barrel—after reports of attacks on Saudi energy facilities—and Canada’s retaliatory tariffs on $20 billion of U.S. goods had already put stocks on the defensive. The Dow took an added hit Tuesday after Amgen shares tumbled 10 percent on news that a Novartis RNA drug trial had failed.

Semiconductor stocks were the exception, drawing bargain hunters after weeks of profit-taking. The PHLX Semiconductor Sector Index rose 0.76 percent for the week.

Clark Bellin, president and chief investment officer of Lincoln, Nebraska-based Bellwether Wealth, remains upbeat on U.S. stocks over the longer term, even with a bumpy stretch likely ahead.

“The next two months may be volatile for stocks as the market deals with seasonal choppiness and uncertainty from the midterm elections. Once we move past this, the stock market typically finishes the year on a high note with the Santa Claus rally effect,” he told The Epoch Times.