Anything But a Summer Lull

Telemus Weekly Market Review August 14th - August 18th, 2023

The U.S. economy appears to be holding on stronger than most investors and economists expected. Not only has inflation fallen from 9% a year ago to just over 3% today, but the unemployment rate of 3.5% sits below the level it was at in March of last year when the Federal Reserve began its rate hiking campaign. This past week, retail sales were released showing consumers spent more than expected in July, although it appears a healthy Amazon Prime Day fueled the above average spending. 

The strength of the economy has resulted in the bond market digesting the fact that the Federal Reserve will be hard pressed to cut interest rates any time soon. They seem unwilling to lower rates when the economy is strong for fear that they might stoke another round of inflation. In fact, this past week minutes from the last Federal Reserve Open Market Committee (FOMC) meeting highlighted expectations from some committee members that they need to see higher unemployment before they feel comfortable concluding that inflation risks have sufficiently dissipated. Given these evolving expectations, yields on Treasury bonds have been steadily moving higher throughout August. The rise in yields has been more pronounced among maturities five years and longer. 

Higher interest rates have been bad for stocks. This past week the S&P 500 declined by 2% and is down nearly 5% thus far in August. Given the stock market’s steady year-to-date rise coming into August, a modest pullback is not unexpected. What is interesting is that better economic news has begun to be interpreted negatively for stocks. The primary reason being that good economic news indicates the Fed can be more patient in holding rates. Higher rates are bad for stocks as they have the impact of pushing valuations lower. Of late, this has been most impactful for the technology sector, which is down -7.7% thus far in August. 

Throughout much of 2023 we have believed that Treasury yields were not properly reflecting expectations that the Federal Reserve was likely to hold rates higher for longer. Rhetoric out of FOMC members has explicitly called out lessons from the 1970’s and early 1980’s where there were multiple inflationary episodes. The Fed would like to have a once and done inflationary instance and is willing to incur a mild recession if necessary to accomplish this. As rates have moved higher, we now view them to reasonably reflect future expectations out of the Fed. The recent surge in Treasury yields has been propelled not just by the market’s recognition that the Fed will hold rates higher for longer, but technical pressures such as outsized issuance of Treasury bonds by the Federal government and reduced international attraction to U.S. debt (given rising yields in Japanese government bonds). 

A resetting of expectations for both stocks and bonds is healthy given the surprising appreciation in the S&P 500 during the first half of 2023. This coming week will offer anything but a summer lull. Bond investors will be attentive to Fed Chairman Jerome Powell’s presentation at the Kansas City Fed’s annual Jackson Hole symposium. Also, NVIDA reports its second quarter earnings results on Wednesday. Last quarter NVIDA surprised the market with revenue guidance that was 50% higher than expected driven by interest in its semiconductors that support artificial intelligence. Stock investors will be attentive to whether the company can sustain or even expand upon its current sales trends. 

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