Over the past few weeks, you might have noticed a modest retreat in the markets. I’d like to offer my viewpoint on why this adjustment is occurring and provide you with a clear understanding of the situation.
The stock market’s ascent in 2023 was fueled by several foundational factors that have been the subject of conversation all year; better-than-expected economic data, a decrease in inflation, and the Federal Reserve signaling that rate hikes may nearly be done (or are done). These macro factors have collectively contributed to the surge in stock prices and I’m pleased to say that these foundational elements are still intact.
Imagine the market as a pendulum, swinging between optimism and pessimism, with reality lying somewhere in the middle. As we entered 2023, the pendulum was just beginning to retreat from extreme pessimism, with apprehensions of a dire recession and inflationary pressures reminiscent of the 1970s. Thankfully, those concerns did not come to fruition. In fact, the economy demonstrated relative resilience, inflation subsided more rapidly than anticipated and employment remained strong. This reality turned some pessimistic expectations around and seemingly led to a well-deserved rally in stock prices.
The pendulum eventually swung to an overly optimistic stance in July as markets reached a peak. In recent weeks, investors have acknowledged the reality that while the economy remains robust, we must also respect that inflation could be a little more “sticky” and hover above the Federal Reserve’s target of 2%. In addition, while the Fed’s unprecedented rate hike cycle might be tapering, a drastic shift to lower rates appears to be a little further in the future than some may have expected. This reality has driven longer-term interest rates back to their highs, thus sending longer dated bond prices down, and putting pressure on stock valuations.
With the recent retreat, the markets reflect a more accurate depiction of the current economic landscape and much fairer valuations. It is perfectly normal for the stock market to see ~5% pullbacks as these tend to occur several times per year historically and help build a stronger foundation as the weak hands get washed out and replaced by investors looking to put long-term money to work.
Since the macroeconomic foundations remain strong at this time, I view the current pullback as a garden variety, run of the mill, temporary retreat that likely got a little exacerbated due to calendar effects (this time of year has historically produced pullbacks in the market). Last Friday was also the August options expiration (third Friday of every month) and that can tend to push markets around as short-term traders adjust their positions. The labor market remains relatively hot and that may be underpinning the economy as could be seen with recent quarterly earnings largely beating expectations. This helps to cool the valuation fears out there by somewhat offsetting the effects of higher interest rates. Should rates begin to retreat, we could see the markets accelerate back towards recent highs but a period of digestion appears more likely at this point and could be just what we need.
Of course, we will continue to monitor all the market dynamics going forward and report our findings through these missives while making any adjustments we deem necessary to our managed portfolios. Should you wish to discuss any of this in more detail, please don’t hesitate to reach out to our office @ 843-651-2030. Also, feel free to share these newsletters with your friends and family and visit us on our website at www.sabowealth.com or www.facebook.com/sabowealth.