Nicely Neutral: Stocks have worked off the excesses of the first-half run — Week of September 11, 2023
|S&P 500 Index||-1.26||17.43||13.15||11.91||11.07||4,457.49|
|Dow Jones Industrial Average||-0.69||5.99||11.22||10.15||8.25||34,576.59|
|Russell 2000 Small Cap||-3.58||6.20||1.79||8.51||2.91||1,851.55|
|MSCI Europe, Australasia & Far East||-1.21||9.79||19.34||6.72||5.04||2,077.17|
|MSCI Emerging Markets||-1.19||4.12||4.80||-0.86||1.82||973.59|
|Barclays U.S. Aggregate Bond Index||-0.40||0.49||-1.21||-4.71||0.40||2,058.69|
|Merrill Lynch Intermediate Municipal||-0.24||0.95||1.99||-1.15||1.63||301.64|
As of market close September 8, 2023. Returns in percent.
— Steve Orr
First week of September down and no trend change. Depending on your index, since July you are skipping on the clouds in the S&P 500 and NASDAQ 100 or driving lower each week with the Dow Transports. For the boring personalities, mid-caps are stuck in the middle. The mega-cap driven run-up from the first half of the year has given way to back-and-forth consolidation. As with most moves, our markets need time to work off the overbought conditions and let sentiment cool down.
Despite the big swing-down in the 2020 shutdown, stock markets remain above their long-term trend line. That trend line grows around 3% per year, in line with the overall economy. Narrowing our focus to this year, the S&P 500 through last Friday is up 17.4%, close to its July peak gain of 19.5%. That is the big index’s best start since 1997 and tenth best since 1926. Coming in the face of 10 interest rate increases, four wars1, and the highest inflation rates since 2008, that is an excellent performance by any measure. Of course, we realize much of the gain was posted by the seven largest stocks, and they were powered partly by easy financial conditions and the artificial intelligence meme of the moment.
Regardless, your fearless writers want to know what is next for markets. Perhaps you, dear reader, would too. History does rhyme, according to Mark Twain. Grabbing our handy Ned Davis Research data library, we find 14 cases where the S&P 500 rose at least 10% through July and then stumbled in August. Returns for the rest of the year were all positive. Those 14 cases suggest the early year strength rebounds later in the fall to power median additional gains of 8.7%. Just adding to this year’s gains would be an excellent accomplishment, in our view.
Last week we looked at long-term interest rates. We continue to believe the path for rates the rest of this year is a slow grind higher. The Fed likely raises rates one more time at either the November or December meeting. They have telegraphed in speeches that a rate change later this month is off the table.
Wall Street remains in the camp of lower rates in the coming year. Either they believe the Fed will cut rates in front of an election or the Most Anticipated Recession Ever will be so bad that the Fed will panic and cut rates. Did that make sense? The consensus is that the next six months will be like the previous five recessions: job growth and earnings turn negative, the Fed panics and cuts rates, then bond prices soar and their yields drop. Stocks then get the benefit of lower interest rates. We’ll see.
We remain on the fringe of consensus. Our base case has not changed: a slowdown in late 2023 into 2024 as higher rates take hold in the U.S. Overseas, Europe is treading carefully near the recession cliff. France’s and Germany’s industrial output is in contraction. China, thanks to strict shutdown protocols and a faltering real estate sector, has yet to reopen. Here at home, there are several fundamental headwinds that could lower earnings and dent the “No Landing” hopes on Wall Street.
What could upset Wall Street’s “No Landing” or “Soft Landing” mantra of the moment? Keep rates relatively high, stocks and the economy slowing into a recession? Let’s start small. A small group of consumers consume a relatively large amount per capita. That would be the college/trade school loan program borrowers. The shutdown relief on student loan payments ended last month and payments restarted last week. Early inflows suggest the next 12 months of payments could lower GDP by around 0.3%. Not a big percentage but if an earnings slowdown of 0.75% to 1% materializes, then we are looking at sub-1% GDP growth in an election year. So, there is a chink in the consumption armor.
Higher oil prices are on offer through the end of the year. Saudi Arabia and Russia like the fact that demand growth has not slowed around the world. U.S. output is at a peak, constrained by lack of funding and skilled labor. Price is now a supply issue, as opposed to two years ago when demand vanished temporarily (“transitorily”). The Administration shot its supply bullet last year with sales from the Strategic Petroleum Reserve, and OPEC+ knows we do not have fracking or a ready reserve to counter their holding back production. Shades of 1973 and higher inflation readings this fall!
Remember our Strike Watch list from a couple weeks back? Add the UAW walking out on the Big Three, led by feisty Shawn Fain, for this Friday. Two big contract points: the union wants to get paid for 40 hours of work while only working 32 hours, and a 46% raise over four years. Fain has threatened to walk out on all three automakers at once. That would send around 144,000 members to the sidelines. The union has about one month’s wages in its strike fund for that number of workers. A walkout on all three automakers would certainly put Michigan into recession in the fourth quarter and possibly endanger a number of parts suppliers around the country.
This is inflation week. Expect CPI to rise slightly to 3.6% and the core reading to stay above 4%. The recent gasoline price rise is not yet factored into last month’s numbers. Friday is monthly and quarterly options expiration so do not be surprised if stocks bounce around a bit towards the end of the week.
We think the choppiness will continue as D.C. ramps up the budget drama. History should repeat with a year-end rally once Congress agrees on flat spending year-over-year. September through March before an election is usually bumpy for all markets but gives way to strength in the election year summer.
It bears repeating, intermediate and long-term trends for stocks are still higher. We do believe any corrections in the next couple of months may be buying opportunities to put cash to work.
1Four wars: space, cyber, Ukraine, and Africa coups
Steve Orr is the Managing Director and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. Steve has earned the right to use the Chartered Financial Analyst and Chartered Market Technician designations. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary’s University School of Law. Follow him on Twitter here.
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