Stolper Perspectives For The Quarter ending September 30, 2023

Category: Uncategorized

The man fixed squarely in the beam of the economic spotlight in the U.S., and arguably the world remains the same. That man is Chair of the Federal Reserve, Jerome Powell. In the days leading up to the Federal Open Market Committee decision announcement this month, financial headlines were dominated by a fervor of ‘will he, won’t he?’ speculation, with the vast majority correctly believing he wouldn’t. And, on September 20th, Mr. Powell duly announced that Federal Reserve officials voted to hold interest rates steady at a 22-year high.

The Chair does not get to shun the limelight now though. Next up is weighing the likelihood that he can pull off a notoriously rare soft landing, named as a nod to the groundbreaking moon feat, whereby the Fed tightens just enough to slow the economy and cool inflation without causing a recession. Of course, other factors are influencing market performance although you wouldn’t always know it given the rate fixation shown by the financial press. But despite the continued handwringing over looming recession fears, the U.S. economy has shown surprising resilience.

The S&P 500 closed on September 29th at 4,288 representing a negative return of -3.28% for the third quarter, but a robust 13.06% for the first nine months of 2023. The Dow Jones Industrial Average (DJIA) ended September at 33,508 for a similar return of -2.11% in the past three months but a decidedly more muted 2.73% for the year to date, once again mainly attributable to a lower weighting in the technology sector. Both major indices peaked this quarter at the end of July and have since drifted down in a choppy manner.

Compared to last year, the S&P 500 is still having a standout run so far in 2023. The S&P 500 declined close to 25% in the first nine months of 2022 but has since staged a recovery and is now 10.6% below its all-time closing high of 4,797 at the beginning of 2022. Likewise, the DJIA is 8.9% shy of its January 2022 record of 36,800.

Value stocks have mounted a relative comeback in recent months, but not one sufficient to overcome the startling rally of the tech-heavy so-called “Magnificent Seven” stocks in the first half of this year. This was on the back of growth stocks suffering their worst calendar year in decades during the 2022 bear market. Going into the final trading week of the quarter, Large Cap Growth investment style has returned a whopping 25.4% since January, while Large Cap Value has managed a much more meager, but still positive, 3.1%. The Utilities sector is the laggard, down 7.9% year-to-date, while Communications Services and Information Technology are well in the lead at 40.6% and 34.5% gains respectively. Consumer Discretionary is the other standout, up 28.1%.

With the federal funds rate range held steady at 5.25%-5.50%, the level it was raised to in July, attention is now on the forward trajectory. Federal Reserve officials are divided, with most currently favoring one more increase before year-end, adding to the rapid series of hikes over the past eighteen months. At his September 20th news conference, Jerome Powell emphasized once more that any decision will be data-driven. More evidence is required that the recent slowdown in inflation figures can be sustained and that pandemic idiosyncrasies are no longer creating skews before the Fed can express comfort with the status quo or consider easing.

For now, all indications are at least that 2024 will see higher-for-longer rates than was anticipated earlier this year. That said, Mr. Powell repeatedly used the phrase “proceed carefully”, indicating caution when it came to overstepping targets in this tightening cycle, while also stating that “the process of getting inflation sustainably down to 2% has a long way to go.” In this tightrope balancing act, he is aware there is a lag between action and consequences. “Forecasters are a humble lot with much to be humble about,” he expressed. Larry Adam, Raymond James’ Chief Investment Officer, cited in his September 15th commentary that the bank’s economists are forecasting that the upper limit of the fed funds target range will fall to 4.5% by year-end 2024 on the back of a mild recession in the first quarter and rate cuts in the second half of next year.

This higher-for-longer mantra has propelled Treasury yields to multiyear highs and contributed to a pullback in U.S. equity markets going into quarter-end, especially within the technology and growth-oriented Nasdaq Composite where valuations are more heavily dependent on projected future earnings, discounted at prevailing rates. The day after the Fed September meeting, the 10-year Treasury yield (a determinant for mortgage rates) reached 4.48%, its highest level in more than fifteen years, while the 2-year Treasury moved higher to 5.20%, bringing it to a level not seen since 2006.

The yield on 2-year U.S. Treasury notes has been above that for 10-year Treasuries since July 2022, marking the longest yield curve inversion since 1980. This is often interpreted as a negative near-term barometer indicating shorter-dated economic dangers are seen as exceeding the risk of holding longer-dated debt.

The dampening of demand for rate-sensitive purchases such as homes and vehicles due to rising bond yields does some of the economy-slowing work that Fed hikes aim to achieve. The average 30-year mortgage rate in America now stands around 7.2%, well over double the sub 3.0% rates seen at the end of 2020 and going into 2021 and the highest level since December 2000, according to the Mortgage Bankers Association. Lack of resale inventory, as homeowners stay in place, has benefitted home builders who are using strong balance sheets to offer mortgage-rate “buy-downs.”

These Treasury yield moves coincided also with the release of new U.S. unemployment data revealing that initial jobless claims came in at their lowest level since January, fueling the belief that the Fed will be forced to act to further cool the economy. Officials are still, however, forecasting a moderate rise in unemployment from the 3.8% figure reported in August to 4.1% at the end of next year. These figures are still historically low.

This summer has seen a wave of U.S. worker strikes with hundreds of thousands of autoworkers, actors, screenwriters, baristas, and hotel industry workers set to be joined by more than 75,000 employees from Kaiser Permanente, the largest nonprofit healthcare organization in the U.S., if a labor agreement cannot be reached before union contracts expire on September 30th. The Bureau of Labor Statistics tracked 4.1 million lost workdays from labor action in August, the most since August 2000.

While strikers express varying grievances, the phenomenon reflects the increasing leverage workers wield in this tight labor market. As we write, Joe Biden has announced he will travel to Michigan to join the picket line of auto workers staging a nationwide strike, in arguably the most public display of union solidarity ever by a sitting president. Upward pay pressure is at odds with the Fed’s wish to slow wage growth to help cool inflation.

According to data from the Bureau of Labor Statistics, annual core inflation, which excludes the more volatile energy and food prices, slowed to 4.3% for the twelve months ending in August, its slowest pace since September 2021. Fed officials are projecting it will edge down to 3.7% for the fourth quarter and fall to 2.6% during 2024.

However, the headline Consumer Price Index, which includes food and energy, jumped 0.6% month-over-month in August, or triple the 0.2% increase for July. Over half of the increase was due to higher gasoline prices. On an annual basis, prices overall were up 3.7% in August versus 3.2% in July.

Going into the last week of September the WTI Crude oil price edged over $90/barrel, a 2023 high and up over a third since the start of July. The main reason behind this surge is voluntary cuts in output by Saudi Arabia and Russia, which have been extended until year-end. The cuts, intended to support oil prices, threaten to drive inflation higher while dampening growth, introducing the danger of an unwelcome “stagflationary” shock. Prices at the pump, however, have not risen apace as prices are dampened by the slowdown in demand following the summer driving season.

Amid the push and pull of labor supply and demand and the squeeze of prices that continue to rise, combined with rising borrowing rates, consumer spending or personal consumption expenditures (PCE) comprises roughly two-thirds of gross domestic product (GDP), has so far remained robust. This has helped underpin a remarkably resilient U.S. economy despite the Federal Reserve’s most aggressive moves in forty years. Atlanta Fed Q3 GDPNow growth estimate now stands at 4.9% on an annualized quarterly basis.

In the political realm, DC is back to regular order following the August recess, and the markets are eyeing what fallout might result from the looming fiscal showdown in Congress that could lead to a government shutdown. As we write, the hours are ticking down to reach a resolution. The Democrat-controlled Senate has voted overwhelmingly to pass a short-term funding bill that has bipartisan support and would avoid a government shutdown until November 17th, giving Congress more time to reach a longer-term budget deal.

But for that bill to become law it would have to pass in the House where Republican factions are locked in a dispute. Some hard-right representatives want to lower the $1.6 trillion top-line budget agreed upon by House Speaker Kevin McCarthy and President Biden earlier this year. If no deal is reached, hundreds of thousands of federal workers are set to be furloughed. Hopefully, as you read, the crisis was avoided.

On the international front, the conflict in Ukraine triggered by the invasion by Russian troops in February 2022 rages on. Ukraine’s president and wartime leader, Volodymyr Zelensky, made recent visits to Washington and New York. He addressed the United Nations General Assembly, delivering fiery remarks critical of some European allies. He later offered profuse thanks to both the U.S. and Poland for their ongoing support. In July, during the North Atlantic Treaty Organization (NATO), Zelensky vented over what he called NATO’s “unprecedented and absurd” resistance to advancing Ukraine’s candidacy for membership. His remarks were said to have irked President Biden and close advisors, although Mr. Biden has since pledged advanced long-range missiles to help the Ukrainian counteroffensive. In a September interview, the Ukrainian Defense Minister said about $100 billion in military aid has been received from Western supporters since the war began, including more than $50 billion from America.

Economically, there has been a divergence between the relative strength of the U.S. economy and major regions abroad. China is struggling to spur growth against a backdrop of sinking exports, a protracted housing slump, and weakening consumer confidence. President Xi unexpectedly withdrew from September’s G20 summit in India, his first absence since assuming power. Relations between China and the summit’s host, India, have been strained over borders and India’s expanding ties with the United States. Biden and Xi may meet in November at San Francisco’s Asia-Pacific Economic Cooperation (APEC) summit, which would provide an opportunity to diffuse tensions and help market stability.

According to the International Monetary Fund, weakness in manufacturing is expected to shrink Germany’s trade-dependent economy this year. In a close call, the European Central Bank (ECB) raised its key deposit facility rate another 0.25% to 4.0%, the highest level since the euro was introduced in 1999. ECB President Lagarde hinted that, although rates will remain high until inflation drops to 2%, policymakers may be done with raises. In the U.K. the Bank of England held its benchmark rate steady at 5.25% in September for the first time in nearly two years as headline inflation unexpectedly fell in August to 6.7% from 6.8% in July, despite climbing energy prices.

We at Stolper Asset Management don’t engage in predicting if an economic soft landing can be pulled off here at home, but we do know that history tells us they are rare because they are tricky to pull off. The recessions of 1990, 2001, and 2007 were all preceded by commentators heralding a soft landing, Economists say that, since World War II, the U.S. has achieved only one durable soft landing, in 1995. The Fed could stay too high for too long, growth could accelerate lighting a fire under inflation, energy prices could keep rising, or some unforeseen new crisis could erupt.

While our investment results are indeed affected by these big-picture vacillations, we stick to our bottom-up approach, with a focus on identifying opportunities at reasonable valuations that have the potential to thrive in the long term under a broad range of conditions. While patience is required, at certain times much more than at other times, we have confidence in this long-term approach.

In turn, we thank you for the continued trust you place in us as your financial advisor, and we wish you and yours health and happiness as we leave summer’s heatwave behind and enjoy the beautiful fall season!

The S&P 500 is an unmanaged index of 500 widely held companies and over 80% of the U.S. equities market.  The Dow Jones Industrial Average (DJIA), commonly known as “The Dow”, is an index representing 30 companies maintained and reviewed by the editors of the Wall Street Journal.  The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of the investment adviser representatives of Stolper Asset Management and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.  Investing involves risk and you can lose principal.  There is no assurance any strategy will be successful.  There is no guarantee that any forecasts made will come to pass.  Past performance may not be indicative of future results.  This information is not intended as a solicitation or an offer to buy or sell any security referred to herein.  Dividends are not guaranteed and must be authorized by the company’s board of directors.

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