The Economy: This summer, economic growth was spurred on by travel and leisure spending from consumers. In November 2022, we saw estimates for 2023 GDP at 0.3%. In August, estimates were around 1.5%. As the summer spending supported the economy, many economists have since lowered their probability of a recession. However, Raymond James’ analysts still expect a recession in the first quarter of 2024 for several reasons:
Consumer Challenges: Interest rates are moving higher as we have seen mortgage rates double as compared to two years ago. Auto loan and credit card rates are also high. The excess savings that the consumer built up during the pandemic are nearly gone. Thus, the consumer is not able to absorb higher costs as easily. We have seen delinquencies begin to tick higher in auto loans, credit cards, and mortgages. Nonresidential investments from government policies have kept manufacturing and nonresidential structures strong thus far, pushing a recession further out. The labor market has remained strong thus far. However, it is beginning to slow, and forecasts show it could begin to contract in the first quarter of 2024. The business investment portion of the economy is driving economic growth, but it too is expected to decrease.
Federal Reserve Policy: We saw CPI released on Wednesday, September 13th, coming in slightly higher at 3.7% vs. the expected 3.6%. A large driver of this increase was energy costs and a surge in gasoline. Given that the Federal Reserve is extremely focused on bringing inflation down, Raymond James’ analysts expect the Federal Reserve to raise rates at least 0.25% by the end of the year, but they do not believe the Federal Reserve will go beyond 5.75%.
Fixed Income Markets: August saw the highest 10 Year Treasury Yield (4.34% ) since 2007. Due to the continued increase in rates, the bond market has struggled. This is the first time in a long time that we have seen back-to-back summers with negative bond market performance.
That negative performance had several sources: We have seen positive economic momentum over the summer. The Citi Economic Surprise Index measures the “surprises” in the economy, which have been positive this year. The 10 Year Treasury tends to move in tandem with this as we have seen those yields rise. The Treasury department has estimated they will issue $1.85T in new debt in the second half of the year, which is a large upward revision. This caught the market by surprise. We have seen increase in rates globally. Specifically, Japan has historically kept their rates near 0 since 1999. They have relaxed the ceiling on longer term debt which has pushed long term rates higher.
Despite the recent yield increase, fundamentals point to lower yields over the 12 next months: The Fed’s policy has changed from being rather accommodative to restrictive over the last year and a half. We have not seen rates this high since the Great Recession, and the increases are not fully priced in yet. Due to the Fed’s restrictive policy, we believe inflation will continue to trend down which will support yields moving lower as well. As we expect a mild recession in the first quarter of 2024, the market could experience a growth surprise following it, which would likely bring yields down.
If we see yields decrease, what does that mean for bond performance going forward? Historically, starting yield has been a good predictor for future returns. Given that the starting yield in 2023 was 4.7%, bond returns are likely to be more attractive the next 10 years than the last 10 years. On average, bond yields fall 100bps after the last Federal Reserve’s final rate hike. Bonds are attractive compared to equities for income as the yield on the U.S. Agg is 3.5% higher than the dividend yield on the S&P 500.
Politics Update: Washington is about to heat up with upcoming votes on some important legislation that expires the end of September.
Adding to this fall volatility and potential gridlock are several events: The next GOP debate on September 27th, the October GOP debate, another debate possibly in November, and the Iowa caucuses on Jan 15th.
We will see some important votes with the House of Representatives returning this week from their summer break. We have renewed legislation like the Child Care Fund Expiration and the Student Loan Payments that resume in October. These are drivers of the economy and could impact the economy if not renewed.
What is the probability of a government shutdown and the market implications? Historically, government shutdowns can have short term impacts but typically have very little impact on longer term investors. The likely outcome is a continuing resolution to fund the government for 30-60 days. If we don’t get a continuing resolution by Sept 30th, we will see a government shut down. In the past, following a government shutdown, the S&P 500 was up 3% with no sector standing out as a winner or loser.
2024 Presidential Election: Biden is the most likely nominee for the Democratic party. However, two areas of concern for the party are the net approval rating and direction of the country. The net approval rating is currently -13.8%, and 64.9% of people believe the direction of the country is on the wrong track. The upside for Biden is that incumbents typically don’t lose, but you will note that the majority of incumbent losses come when we have a recession during the prior year.
Who is the most likely Republican nominee? President Trump has a 40% lead vs. the field, but there are more debates to come. Historically, one year from election, every potential Republican nominee who held a lead was the eventual nominee [one exception was Rudy Giuliani in 2008].
Equity Markets: Historically, there has been a strategy called “Sell in May and Go Away”. It refers to a period between Memorial Day and Labor Day that has historically been a challenging time to own stocks.
2023’s summer saw an 8% return in the S&P 500 over that time frame, which is the 7th time in the last 8 summers.
Earlier in the year, we saw several sectors take the lead and support the market. However, over the summer, we have seen several of the lagging sectors catch up. The stock market has had a good year so far this year as most indexes are up 10-20% YTD. Raymond James analysts maintain a 4400 year-end target for the S&P 500 and a 4600 target for next summer. Thus far this year, we have only had one 5% pullback which was fairly quick during the banking crisis in March. On average, we see about 3-4 pullbacks of +5% per year. While we have seen some volatility this year, the market has fared much better. Consensus EPS estimates for the remainder of 2023 and 2024 are higher which should be a catalyst for the market and provide some positive momentum going forward.
Equity Earnings Season: Earnings did come in better than expected, and recessionary expectations have been pushed further into 2024. Margins have compressed, but they are still positive. Labor prices and inflation have decreased margins, but businesses are focused on efficiency which will help bolster with margins. The consumer continues to be discerning. The top end consumers are continuing to spend money, and there was record spring and summer demand for travel and events/excursions. However, other consumers are starting to slow the amount they spend, and credit card debt is near all-time highs. Secular trends support the tech sector. Higher rates have historically been a headwind for the tech sector. However, every other sector relies on technology to maintain their businesses. We have seen immense spending in AI and the cloud, which has supported tech earnings. Financials remain healthy. Despite fears earlier in the year, banks’ balance sheets are healthy; deposit outflows have stabilized; and loans are still being made. Increases in dividends and share buybacks have persisted as banks continue to pass the Federal Reserve’s stress tests. We are not bullish on Chinese related companies as those with the most exposure to China have struggled so far this year.
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Fehrman Investment Group and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. This is not a recommendation to purchase or sell the stocks of the companies mentioned. Investing involves risk and you may incur a profit or loss regardless of the strategy selected. Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investors’ results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions.