Market Review for August 2023

Market Review for August 2023Goldilocks Scenario

Inflation is down; the Federal Reserve (FED) will cut rates by December of this year, and we continue to see strong GDP numbers with low unemployment. We have beaten inflation, and the markets will continue to move forward at full steam...

…not so fast! What I have described to you is a consensus belief many have today.

Now albeit, we have seen inflation come down substantially on a year-over-year basis from last June when the Consumer Price Index (CPI) was reading at 9.06%, relative to 3.18% released this past month. The issue with this number is that we are looking at a year-over-year comparison, and it’s extremely difficult to repeat a 9% inflation print.

As we get closer to the lower CPI prints from the back half of last year, it will be more difficult to continue to see the YoY numbers improve significantly. Not only does it become more difficult to lower the CPI numbers on a YoY basis, but we also expect oil and gas prices to be higher to round out the year. Energy plays a substantial role in the CPI number, which does not bode well for the market consensus of CPI coming in lower than the FED’s 2% target.

This leads us to the second point of our argument against the consensus: with inflation remaining elevated for longer due to headwinds on a YoY basis and from rising energy prices, we believe it’s much more likely that the FED is unable to cut rates this year and they may not even be able to cut until after Q2 of 2024.

According to the Federal Reserve Bank of Atlanta, there is roughly a 70% chance that the FED will cut rates below the 5.25-5.50% target range we are at today (9/5/2023) by June 2024. However, there is a similar probability that we are above the current levels by 25 basis points as there is if we are below by 25 basis points. Again, we reiterate that the market is pricing in too much optimism about the FED cutting rates.

Last, we continue to see strong gross domestic product recordings as of the end of August. With this, we have also seen stronger-than-expected earnings outcomes for the S&P 500. According to FactSet, as of September 1st, 79% of the companies who have reported Q2 earnings have beaten estimates by an average of 7.5% percent, which is below the 5-year average of 8.4% but also above the 10-year average of 6.4%.

However, the index is also reporting its third straight quarter of year-over-year declines in earnings. In our opinion, the YoY declines in earnings are more substantial, as this demonstrates the lack of overall growth in the underlying earnings number. Companies will strategically lower guidance when the company is under pressure and facing headwinds, which we saw most of last year. Companies continue to beat their previous guidance this year, but the actual numbers are lower than a year ago.

All-in-all, we feel that there is still room for optimism as we get closer to going through this inflation-driven tightening cycle. Because of increased efficiencies and tools such as AI, we feel strongly about the US economy and markets long-term and maintain our stance that the United States will continue to be the powerhouse for innovation and technology for the next decade, which bodes well for the markets.

That said, we do not feel like we are out of the woods yet and think there is still turbulence ahead as we close out the year. For now, we look at attractive opportunities such as lengthening duration within our fixed income allocation and maintaining our overweight stance towards value and quality within our equities.

“Success requires enough optimism to provide hope and enough pessimism to prevent complacency.”– David Myers