Monthly Market Update - August 2023

Highlights:

• The S&P 500 maintained its upward momentum, increasing 3.2% in July and bringing its year-to-date return to more than 20%.
• The economy showed positive signs with four quarters of economic expansion, lower core inflation, robust auto and home sales, and strong job demand.
• A recession in corporate earnings, softening retail spending, and the potential lagged impacts of rising interest rates remain grounds for caution.

Optimism reigned once again in July as the S&P 500 tacked on another 3.2%, pushing the year-to-date return over 20%. The positives weren't obscure. We've witnessed four quarters of economic expansion, with second quarter GDP up an annualized 2.4%. Core inflation ticked downward, and auto and home sales were robust. Job demand remained firm. Is it possible that the economy is adjusting rather smoothly to higher interest rates? Could the Federal Reserve have achieved its ideal result - a soft landing? It would certainly defy previous consensus expectations that the Fed's dramatic rate increases would trigger a significant recession.

But despite the stock market's results, the jury is still out. We’ve seen this story before as wide expectations of a soft landing in late 2000 and 2007 were soon upturned. With the exception of some notable technology firms, we are currently in a corporate earnings recession, with the year-over-year S&P 500 average earnings down some -7%. Consumers' Covid nest eggs are on the verge of being spent down, and we're seeing the impact as discretionary retail spending is softening. The waning of so-called "revenge spending" in the wake of pandemic lockdowns is being felt through the service economy, as indicated by dipping airfare and hotel rates. Part of the economy's resilience in the face of higher costs of borrowing can be credited to businesses doing a good job of locking in lower rates before the Fed hikes started. But these lower rate loans have expiration dates, and publicly traded companies will face steep increases as they refinance over the coming years. The cost of borrowing is already affecting business start-ups and is a primary reason existing home sales are stagnant. Slowing global economies have hurt U.S. exports. It's also likely that the impacts of the Fed's hikes have not yet been fully expressed since rate increases can take up to two years to filter through the economy.

So how should investors proceed? We lean toward prudence as we look at an overall market that seems priced for perfection with a price-to-earnings multiple north of 19 times. Locking in 5% returns in high-quality bonds remains an attractive alternative, particularly for investors prioritizing capital preservation. Careful and opportunistic stock picking is our preference, even though this year's market has been driven by a small number of hot technology firms. While keeping up with this narrow market without a significant share of these leaders can prove challenging, we like to remind our investors that in similar exuberant markets of the past, the real value an active manager can provide comes from protecting gains when the inevitable downturn occurs.

In this month’s Q&A, Drew Justman, Dividend Income Portfolio Manager, explains why he thinks dividend paying stocks are not participating in the overall market rally and where he sees opportunity in the market moving forward.