It’s that time of year again! The kids are back in school, weekends are filled with football games and the relentless summer heat is subsiding. Moreover, this is a time when the institutional powers return from their Hamptons retreats to reclaiming their money management roles from their understudies and scour recent data in search of the pivotal insights that will steer the markets in the fourth quarter.
This year, however, they will find that not much has changed since they left in June as there have been no substantial shifts in the economic dynamics. Truth be told, we remain in this boring cycle of data dependency where traders bid up the markets when reports hint towards a soft landing (cooling inflation and strong economy) and cull their bets when those reports hint at a recession looming due to stagflation (continued inflation and slowing economy). Yes, this story is getting old, and I am getting tired of writing about the same stuff, but I don’t get to control the markets narrative so lets go over what’s taken place recently.
Below is my summary of recent developments in the five macroeconomic factors that should play a major role in determining our future economic path:
1. **Economic Growth**: Some indicators have hinted at a slight dip in the positive momentum of the U.S. economy. While this hasn’t raised concerns of a severe downturn, it does indicate less resilience compared to previous months, although expansion continues.
2. **Inflation**: There has been a mild uptick in some inflation indicators, such as within the ISM Manufacturing and Services PMIs of recent, while the Core CPI data met expectations this morning. None of this is significant enough to suggest that disinflation is ending, but it hints at the possibility of a persistent, or “sticky,” inflation trend.
3. **Jobs**: The labor market remains robust, with jobless claims at a seven-month low. This, in and of itself, isn’t a horrible thing as it keeps the economy chugging along, but unit labor costs have risen slightly, which could present challenges for the Fed in managing inflation. Recent JOLTS report did show fewer job openings, and this could cool those wage inflation pressures.
4. **Interest Rates**: Yields have been near their highs lately, reflecting market reactions to the above factors. A significant yield collapse would signal recession fears while a surge in yields would put upward pressure on the dollar. These two forces acting in tandem would certainly put pressure on stock valuations, so I’d like to see a mild retreat in yields, but nothing too dramatic at this point.
5. **Federal Reserve**: While investors believe the rate hike cycle is over, expectations for the first rate cut have been pushed further out. This shift may increase the risk of the Fed’s policies lasting too long, potentially leading to a mild economic contraction.
In summary, while there have been some developments, none indicate a significant deterioration in the overall economic outlook. Both the stock and bond markets have adjusted to these factors and are trading at more reasonable valuations than were seen when the data looked “too good to be true”. Markets have no trouble becoming overly exuberant in the short term and market pullbacks are a natural part of the investment cycle as investor expectations get reset. For now, this pullback appears to be just that, but close attention is warranted should a material breakdown occur in both price and economic trends.
As previously mentioned, the bond market is still facing pressure as interest rates hover near, or slightly above multi-year highs. Higher rates result in lower bond prices and to mitigate this risk, we maintain our positioning in assets that are less affected by interest rate fluctuations within our managed accounts. These assets are currently offering attractive yields and stable prices.
Considering that we should be a lot closer to the end of this interest rate hiking cycle than the beginning, it may be prudent to consider taking on some duration risk by investing in longer-term fixed-interest rate securities to secure these attractive rates for the future. However, the present volatility in this trade is a concern, and many are reluctant to endure short-term turbulence in their fixed-income portfolios, especially after the market turmoil experienced in 2022. At some point, we will need to weigh the potential long-term rewards, but for now, the stability in prices and the high yields provided by short-term fixed-interest rate securities offer a more comfortable investment option.
Regarding the broader stock market, the intermediate-term trend in major indices remains positive. The recent short-term pullback appears to align with historical seasonal patterns observed in August and September. Therefore, we are maintaining a neutral stance with respect to our equity allocations.
Notably, the “Growth over Value Trade” has regained momentum, primarily driven by positive developments in the technology sector. Defensive sectors like Utilities have struggled to gain traction, while cyclicals have performed reasonably well in between these two extremes. Year-to-date performance disparities persist between indices heavily weighted with “Magnificent 7” growth stocks (such as Apple, Tesla, Nvidia, Amazon, etc.) and those less exposed to them. The NASDAQ and S&P 500 continue to outpace the Dow Jones Industrials, which predominantly features traditional blue-chip stocks, by a significant margin. If historical patterns hold true, we anticipate this margin will narrow, and there is a likelihood that blue-chip stocks will catch up as we progress into the fourth quarter.
This broadening effect, where a majority of stocks are advancing (rather than a select few growth names), would dramatically improve the technical backdrop while providing the fuel to see new highs. But most importantly, it would improve investor sentiment and give me soothing more exciting than economic data to write about in my upcoming newsletters!
Should you wish to discuss the current markets, our strategy, or anything other than economics, 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 via email and visit us on our website at www.sabowealth.com or www.facebook.com/sabowealth.
Important Disclosures: Past performance is not a guarantee of future results. The statements contained herein are solely based upon the opinions of Edward J. Sabo and the data available at the time of publication of this report, and there is no assurance that any predicted or implied results will actually occur. Information was obtained from third-party sources, which are believed to be reliable, but are not guaranteed as to their accuracy or completeness.