Don’t Wait Outside of the Storm

09.18.2023

The year 2022 was a bloodbath for both equity and bond markets–the S&P 500 was down 18% and the Bloomberg US Aggregate Bond Index had its worst year ever, down 13%. This year, 2023, began with the US debt ceiling standoff, followed by a banking crisis, and continued rate hikes by the major central banks. The economy seemed like it would get worse before it got better, and the consensus was calling for a near-term recession. However, the stock market quickly shrugged off many of these concerns. Year-to-date as of August 31, the S&P 500 is up approximately 17% and NASDAQ is up approximately 34%. The S&P 500 is officially in a bull market (i.e., up at least 20% from its recent lows in October 2022). With the Federal Reserve and some economists no longer forecasting a recession[1], it makes one wonder what has changed in the last few months.

From the market’s perspective, here is what went right:

A deal was struck between the Democrats and the Republicans to raise the debt ceiling, bringing the stalemate to an end.
On March 10^th, 2023, Silicon Valley Bank (SVB) collapsed due to a bank run caused by customers withdrawing billions of dollars. This bank run eventually led to the collapse of Signature Bank and First Republic Bank. Promptly, the Federal Deposit Insurance Corporation (FDIC) announced that they would guarantee all uninsured deposits, and soon after that it was announced that First Citizens would acquire SVB, New York Community Bank would acquire Signature Bank, and JP Morgan would acquire First Republic Bank, bringing the regional banking crisis to an end.
After hiking the federal funds rate from 0% to 5.25% in just a 15-month span, the highest in 22 years, the Fed pressed pause at their June meeting, giving the market hope that further hikes may not be needed.
The US economy grew faster than expected – annualized Q1 GDP was 2% and annualized Q2 GDP was 2.1%, buoyed by resilience in consumer and business spending.
Inflation has steadily declined, reaching 3.2% in July, the slowest annualized rate in more than two years.

On the surface, these events are very encouraging, but if we look more closely, not everything is as promising as it seems:

Inflation is cooling but it is still far from the Fed’s target of 2%. With the reacceleration of the US economy, it becomes harder for the Fed to reach its inflation goal without further rate hikes.
Price levels are still high. Although July’s inflation was only 3.2%, down from July 2022’s inflation of 8.5%, compared to July 2019, price levels have increased significantly, and are unlikely to fall.
US core inflation, which excludes volatile items such as food and energy, has been more stubborn. The core inflation for July was 4.7%, compared to the average core inflation of 2.2% in 2019 and 2.1% in 2018.

_{Source: https://www.usinflationcalculator.com/inflation/united-states-core-inflation-rates/}

The unemployment rate is the lowest in decades at 3.5% for July. Of course, that’s good news but with average hourly earnings up 4.4% over the past year, this puts further upward pressure on inflation due to the increase in disposable incomes.
July job openings remained elevated at 8.8 million. With 5.8 million people looking for jobs, there were 1.5 job openings per unemployed person, giving employees the upper hand to negotiate wages, which can result in wage inflation.

_{Source: U.S. Bureau of Labor Statistics}

Looking beneath the surface of this year’s stock market gains indicates the bulk of the gains are accruing to a small number of companies. The S&P500 is up 17% through August, but the equal-weighted S&P500 is only up 6%, which indicates the market momentum so far has been driven by the mega cap companies such as Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla and Meta.
After OPEC announced that it would cut overall oil production by 1.6 million barrels a day in April, Saudi Arabia announced in June that it would cut oil production by an additional 1 million barrels per day. These announcements have caused energy price to rise – the average gas price increased from $3.22 a gallon in January to $3.83 a gallon as of August 31, a 19% increase[2].
China’s post-COVID economic recovery is looking increasingly grim, with a high unemployment rate (approximately 20% of young people aged 16 to 24 are unemployed), low growth (Q2 quarter over quarter GDP growth was only 0.8%), a property crisis, and heightened US/China relationship tension. There may be a spillover effect for the rest of the world as China, the world’s second largest economy, reins in spending.
In early August, Fitch downgraded the US government credit rating from AAA to AA+ due to “expected fiscal deterioration over the next three years”[3]. The downgrade itself was inconsequential but it signaled the expected debt increase for the US, especially given the current high interest rate environment. Since then, the rating agencies, Fitch, S&P, and Moody’s, have been downgrading consumer staples and banks, further indicating troubles exist in the market[4].

Along with the issues mentioned above, the fiscal and monetary policies implemented in the last few years are still working through the system (and at times, the two work against each other), which makes efforts at timing the market increasingly challenging. The first eight months of this year are a solid reminder of the benefits of maintaining a disciplined, long-term investment plan.

Please do not hesitate to reach out if you have questions or would like to discuss your own situation.

[1] https://www.barrons.com/articles/bofa-recession-soft-landing-economy-f2ce2c1e

[2] https://gasprices.aaa.com/

[3] https://www.fitchratings.com/research/sovereigns/fitch-downgrades-united-states-long-term-ratings-to-aa-from-aaa-outlook-stable-01-08-2023

[4] Strategas

Disclosures

This material is solely for informational purposes and shall not constitute a recommendation or offer to sell or a solicitation to buy securities. The opinions expressed herein represent the current, good faith views of the author at the time of publication and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such. The information presented herein has been developed internally and/or obtained from sources believed to be reliable; however, neither the author nor Manchester Capital Management guarantee the accuracy, adequacy or completeness of such information. Predictions, opinions, and other information contained in this article are subject to change continually and without notice of any kind and may no longer be true after any date indicated. Any forward-looking predictions or statements speak only as of the date they are made, and the author and Manchester Capital assume no duty to and do not undertake to update forward-looking predictions or statements. Forward-looking predictions or statements are subject to numerous assumptions, risks and uncertainties, which change over time. Actual results could differ materially from those anticipated in forward- looking predictions or statements. As with any investment, there is the risk of loss.

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