October Market Commentary:  A New Era for the Economy Creates Uncertainty

 September Recap and October Outlook

  The outcome of the Fed's meeting in September was to hold rates at the current level. It has been described as a "hawkish pause," and the Fed was clear in post-meeting remarks and statements that one more increase is still possible in 2023.

 Regarding the impact on the economy, markets, and consumers, a terminal rate that includes one more increase likely is less important than the messaging that rates will be higher for longer. Fewer cuts next year will mean pressure on businesses and consumers, and with inflation still at twice the Fed's preferred level, the impact of this new reality is unknown.

 The post-2008, pre-pandemic era of low rates, low inflation, and ever-expanding values is firmly in the rearview mirror. The term for what we're seeing now is "high-pressure equilibrium," where low unemployment and positive growth co-exist in tension with inflation that is above the Fed’s long-term target of approximately 2%.  

 Let's get into the data:

•  Consumer spending dropped vs. last month. The Commerce Department reported personal incomes rose 0.4% in August, while consumer spending rose 0.4%. This is a decrease from July’s bump of 0.8%
•  GDP expectations were revised up. The Federal Reserve now expects 2023 GDP to increase 2.1%. In June, this number was 1.0%
•  The personal savings rate rebounded a bit in August. The Bureau of Economic Analysis reported a 3.9% rate
• The average 30-year fixed mortgage rate hit 7.53% at the end of September, according to the Mortgage Bankers Association 

What Does the Data Add Up To?

 A soft landing for the economy looks increasingly possible, but the economic plane doesn’t seem to be landing in the same country it took off from. For the first time since the recovery after the Global Financial Crisis really took hold, we may be seeing a lasting change that results in a new cycle.

 If the Federal Reserve maintains the higher-for-longer position on interest rates, it will begin to have lasting implications. The FOMC meeting's Dot Plot of expectations for interest rates in 2024 showed an expected rate of 5.1%, up from 4.6% in June 2023. This implies two interest rate cuts instead of the four that were previously expected. Much tighter money supply over a longer period of time will likely result in pressure on companies that rely on infusions of capital to fund day-to-day operations as well as growth.

 As we face what could be a new economic reality, we see a consumer who has apparently reached the end of the excess savings accumulated during the pandemic. The Federal Reserve Bank of San Francisco recently calculated that excess savings (defined as savings beyond what might be expected based on pre-pandemic trends) peaked in August 2021 at $2.1 trillion. This number had declined to less than $190 billion by the second quarter of 2023. However, Fed economists aren't the only ones analyzing this data; other results aren't as dire.

 The reason savings matter is that consumer spending fuels the economy. It accounted for 68.3% of GDP as of June 2023, according to the Federal Reserve Board of St. Louis. A consumer without excess savings to spend may curtail expenditures, putting downward pressure on the economy. So far, this hasn't happened. But with the credit card balances topping $1 trillion, the cost to consumers of the ongoing spending spree is going up.

 Besides business and personal balance sheets, another area of vulnerability is heightened uncertainty. A government shutdown was barely avoided at the end of September, and the short window to get an agreement on spending is beginning with chaos following an unprecedented defenestration of the House speaker.

Chart of the Month: The Personal Consumption Expenditures Index Is Telling a Positive Story

 The Federal Reserve prefers to look at the PCE Index rather than CPI. PCE shows a normalizing in inflation levels over the last three months.

Source: U.S. Bureau of Economic Analysis. Chart: Axios Visuals

Equity Markets in September

 The S&P 500 was down 4.87%

• The Dow Jones Industrial Average fell 3.50%
• The S&P MidCap 400 declined 5.42%%
• The S&P SmallCap 600 was down 6.16%

Source: S&P Global. All performance as of September 30, 2023

The received wisdom about the equity market is that it hates uncertainty, but it doesn’t seem too keen on Chairman Powell’s efforts to convey how certain the Fed is that rates will not be going down soon. After a strong recovery from the bottom of the market on October 12, 2022, it was looking possible that a new bull market had begun. With another month of declines, the bear may not be ready to hibernate yet.

 Ten of eleven sectors declined over September, and as of September 29, 499 issues had reported, with 76.2% beating estimates on earnings.

As we turn our attention to the charts, we focus on the trend of the SP 500 using the iShares ETF (IVV).  Below you can see that the chart is supporting an uptrend, and the we have two levels of support 1) The 200 Day Moving Average where just recently prices have stabilized and 2) The upward trendline from 2020 lows.  Lets see if those areas continue to provide support throughout the remainder of the year.

 Bond Markets

 The 10-year U.S. Treasury ended the month at a yield of 4.58%, up from 4.11% the prior month, reflecting the market’s move to “risk off.” The 30-year U.S. Treasury ended September at 4.71%. The Bloomberg U.S. Aggregate Bond Index returned -2.54%, with a year-to-date return of -1.20%.

Taking a closer look at the fixed income market, below is a chart of the YTD performance of six ETF's representing different areas of the bond market.  In our earlier posts and market video we discussed the concept of duration or the average length of the bonds in a portfolio, and the lower the duration the lower interest rate risk those bonds carry.  You can see that reflected in the first three ETF's below, as it goes from shortest to longest duration as represented in Red: 1-3 Yr Treasury, Blue: 7-10 Yr Treasury ETF, Green: 20+ Yr Treasuries.  As you can see the shorter duration is actually positive on the year, with the 20+ Yr taking the largest loses.  Now most people own a broad bond portfolio which is most commonly reflected in purple which is the Barclays Aggregate Bond Index, which supports the principle of diversification.  The long term bond portfolio is also illustrative of how banks failed earlier, and the why there is current stress in the financial systems as banks sit on large unrealized losses in the bond portfolio.  At some point the longer duration bonds will find their footing and eventually "snap back" when the fed eases its tightening cycle, stay tuned, as patience with you bonds is required at this moment.  We continue to watch this very closely as we plan to go out in duration to participate in the "snap back" in bonds when the time is right.

 The Grounded Investor

 A new cycle means that it’s a good time to review your balance sheet, your financial goals, and your portfolio.  

 There are a lot of actions you can take to ensure that you remain on track. Are you comfortable with the level of risk you are taking in your portfolio? With the market swinging around, you may want to trim risk, but it’s a better idea to do it thoughtfully. If you decide to sell a position that has declined, you should be harvesting the tax loss to apply against gains. Tuning up a portfolio allocation should be done carefully, with an eye on your overall goals, your desired level of risk, and minimizing the costs and maximizing the benefit.

 As we head into year-end, you'll also want to think through any moves you need to make before December 31. Are you maxing out your 401(k)? If so, have you considered temporarily adjusting your allocation so you minimize market risk? Are you making a charitable donation? Where will the funds come from? The answer may be different now, considering declining market values over the last several months.

 Thinking through your plan and tackling issues one step at a time is key. If the bear is going to continue to growl, you want to be prepared.

 As Always, Stay Grounded.

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The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.