Highlights:
The S&P 500 experienced a 5% decline in the first three weeks of August before rebounding, ending the month down 1.6%, bringing the year-to-date return to 18.7%.
Intermediate interest rates rose sharply, with the 10-year Treasury briefly exceeding 4.3% before ending the month at 4.1%.
The U.S. economy remained relatively strong compared to other developed nations, with optimism for 2024 earnings projections despite recent quarterly earnings declines.
August is traditionally a vacationing month for Wall Street, with lower volumes and an absence of blockbuster deals. However, lower volumes do not necessarily equate to lower volatility. The month saw the S&P 500 Index decline more than five percent in the first three weeks before rebounding strongly in the final week, ending the month down 1.6%. That brought the year-to-date return of the Index to 18.7%. The market continues to be strongly bifurcated. Ten stocks have contributed 14.6% of the gain, while 201 companies are negative on the year, and 108 companies have declined more than 10% this year.
Perhaps the most significant market action during the month was in the bond market, where intermediate interest rates moved sharply higher. The 10-year Treasury started the month below 4%, broke through this cycle’s previous high of 4.3%, then retreated to 4.1% by month end, as the bond market continues to grapple with conflicting data about inflation and the economy.
Core personal consumption expenditures (core PCE), an inflation metric carefully watched by the Fed, showed signs of slowing, giving Fed watchers and investors hope that a further quarter-point rate bump might be delayed or avoided altogether. However, other inflation indicators were mixed, while gas prices edged upward. All of which produced a growing consensus that Fed rates would likely remain high for some time, a shift away from optimistic projections of rate reductions by year end.
Meanwhile, overall economic data remained generally positive, although the lag effects of the Fed’s rate hikes could still be mounting. A strong consumer continued to provide a boost for the economy, even as Covid-period savings appear to be running low. Mounting credit card debt continued to demonstrate the potential strains on spending. One key to consumer strength has been the strong job market, but that too was beginning to show signs of weakening over the past month.
Taking a wider lens, the U.S. economy remains stronger than other developed countries. A slowdown in China, which has global implications, has sparked central government stimulation. Bond yields exceeding 5% make fixed income the most attractive it has been since pre-2008, but stock returns so far this year are a reminder of where the best hedge against inflation and the greatest opportunity for real returns remain. Earnings projections for U.S. companies in 2024 are quite optimistic, even as the final reports from the second quarter of 2023 showed a year-over-year earnings decline of about four percent, marking the third quarter in a row of earnings declines. Debate continues on whether Q2 was the bottom for corporate earnings declines in this cycle. A conservative view of future corporate earnings suggests full valuation for the overall stock market. However, considerable variation by sectors and industries leads us to believe that careful security selection, matched with appropriate asset allocation, will be important factors in performance and risk management for the remainder of 2023 and into next year.
In this month’s Q&A, Bill Ford, Portfolio Manager and Credit Analyst on the Reinhart Fixed Income team, shares his view on the current state of the bond market. Bill dives into where he is finding opportunities and when he thinks interest rate hikes will start stressing corporate balance sheets.