September 24, 2023
Weekly Market Outlook
By Donn Goodman and Keith Schneider
Hello Gaugers. Thank you for tuning in again. This is being written on Thursday evening, so I'm not quite sure what tomorrow (Friday) brings, but today we saw some added fear come back into the market. It was the biggest decline since March.
The past few trading sessions have seen the markets come under pressure, particularly growth stocks. The reason why, of course, is because the Federal Reserve made it quite clear that they may not be finished raising interest rates. While they did pause as a result of this week’s Fed meeting, it was broadcasted that more of its Fed Governors are all for additional rate hikes and promised at least one more later this year (November would be our guess).
It is important to note that the Fed did not hike interest rates at their Wednesday meeting. Nobody thought they would, as evidenced of the very low probabilities priced in the futures markets. However, they did signal to the needs that there is a real possibility of another 25-basis point increase by the end of the year. As notably (and hawkish) the Fed’s dot projections indicate, the first rate cut of 2024 will likely not happen until well into next year's second half.
Higher For Longer.
We have pointed out in previous Market Outlooks (one entitled Higher For Longer) our own belief at MarketGauge that interest rates are NOT coming down anytime soon. While we did recently suggest that the Fed could halt future interest rate rises, we also did allude to the idea that Inflation was ticking up, could go higher, and that rates could eventually see 5.5%-6.0% in the 10-year Treasury. It wouldn’t take the Fed’s actions to cause this to happen as we have been witnessing the 10-year trending higher just in the past few weeks.
The 10-year Treasury rate now sits at the highest mark since 2007. More importantly, it gapped up Thursday morning and broke out to a new high. Because many analysts use interest rates as an important input in their stock valuation, it immediately hit the stock market hard.
Higher rates continue to put pressure on many parts of the economy and stock valuations at a time when we expect the most volatility (September). It is also pulling investment capital out of stocks and into Treasuries, which at this juncture are considered a more attractive risk-free rate of return. More on this in a minute.
See the 10-year Treasury breakout picture from Thursday below which shows the 10-year rate over the past year:
Here is the last 16-year picture of the 10-year interest rate. Notice how low the rates got during the COVID Pandemic as the Fed could not print money fast enough to prop up the economy:
The pain is likely to continue for bond investors. Remember as rates rise, the price of bonds fall and many investors who thought they could get refuge being in fixed income funds are continuing to see principal losses in their accounts.
Bond traders are expecting further yield increases as the Fed’s “higher-for-longer” message seeps in. Part of the problem for fixed income assets is that the economy remains so resilient. Bill Gross, the former bond king, said he expects a third-straight year of losses for Treasuries. JP Morgan & Chase Co. head Jamie Dimon said the Fed may need to hike further to fix inflation. Both said this things before Chairman Powell’s commentary last Wednesday.
For borrowers and people depending on interest rate loans, this all means continual hardship. See chart below:
What the Fed’s rhetoric means for the stock market:
The key aspect of the FOMC hawkish commentary coming out of their Wednesday meeting was whether or not it undermined the “Fed done or almost done with rate hikes”? We do not think it did. We believe that while the Fed’s commentary was indeed more hawkish and perhaps a much more negative market reaction, it did not change the trajectory of their stance in fighting inflation.
The truth is that most analysts had predicted that it was likely the Fed would hike one more time later this year.
Beyond the short-term negative reaction in the markets, the Fed used Wednesday’s statement, dots, and press conference to drive home that rates will stay higher for longer.
So far we have had a 5% correction in the past week. Realistically, that is far more typical than one might expect given the amount of selling and “fear” that came back suddenly in the markets. See chart below:
The two main concerns the market is now faced with in the near-term.
The Negatives.
The economy continues to chug along more robust than most economists expected. Remember most of them earlier this year were calling for a recession by the second half of the year. That has not materialized. Yet, as we explore with you in the remainder of this Outlook, there are REAL concerns that two serious problems could derail the soft-landing rhetoric and throw the stock market into a prolonged correction. They are as follows:
If the markets actually start to believe the Fed’s “higher-for-longer” rate hike threats (and they are starting to) then worries about a growth slowdown will begin to rise. We will show you some of the charts that are making us believe a slowdown could be upon us.
In the short term, fears of a looming government shutdown, the impact of worsening labor strikes, higher energy prices, and signs of economic weakness could all bring the “growth scare” to light sooner than expected. This will inevitably cause the stock market to endure a prolonged correction.
The second concern is a major bounce back in inflation. If the Fed suddenly signals it could hike rates more than once it would only be because they are receiving signs that inflation is about to spike and the trajectory of the CPI/PPI numbers rise. Yes, data these past few months have shown a cooling of inflation pressures, but with the recent rise in energy prices and food delivery problems around the world, it is quite conceivable that inflation could spike.
Let’s now explore some useful charts to show us where these concerns may be showing up:
The Fed is concerned about “steady inflation”. See projection below:
The CEOs of many of America’s largest companies are worried about the economy.
CEO outlook. "Since the Fed started raising rates in March 2022, CEOs have gradually worried more and more about the economy slowing." See chart below:
Another area of concern in the economy is new and used home sales have screeched to a halt. This is an important part of the economy, but higher interest rates are preventing buyers from affording a house given today’s mortgage rates.
Existing home sales (I). Existing "home sales dropped 0.7% MoM leaving sales down 15.3% YoY."
US Leading Economic Indicators are declining. Another area of concern.
US LEI. "The Leading Economic Index declined in August for the 17th month in a row, the longest down streak since 2007-08. The Conference Board is forecasting a decline in real GDP growth from 2.2% in 2023 to 0.8% in 2024."
Philly Fed Manufacturing is weaker than expected.
Philly Fed Manufacturing. "Business Outlook came in substantially weaker than expected dropping 25.5pts to -13.5 or 12.5 below estimates…The weakness was in New orders which dropped 26.2 to -10.2."
Very low unemployment rate.
Unemployment rate vs. SPX. "Historically, the worst time to buy stocks is when unemployment is low (<4%) and rising. This is the current situation."
Fixed income instruments (Treasuries) are becoming more attractive than stocks. At the money management firm I worked with for almost 25 years, our Portfolio Managers spent considerable time evaluating the earnings yield of the stocks we were investing in. It is an important and easy calculation that speaks volumes about the attractiveness of a stock versus a bond. Earnings Yield often reflects the valuation of the market as compared to fixed income rates. This is why many analysts take down stock projected valuations when interest rates rise. See the calculation below:
(think of a stock at $10 and has earnings of $4 a share, that would be an earnings yield of 4% and if a 10-year Treasury Note is at 5%, the Treasury presents a better opportunity).
Earnings yields vs. US10Y. "With the surge in interest rates again today, the earnings yield for the Russell 3000 index is now below 10-year yields for the first time in 21 years." See chart below:
Continuing tightening by the Fed is cutting into GDP estimates. The projections, however, are that we may turn the corner by the second or third quarter of 2024. See chart below:
A looming Government shutdown. Caused by different factions of the Government who want to push their agendas. The tug of war between curtailing spending and continuing to spend money which is driving up deficits is at the core of this feud between both parties. However, history has shown that a government shutdown does not have that large of an impact on the US stock market. See chart below:
Investor sentiment has turned more negative recently. We like to show you the AAII (American Association of Individual Investors) bullish and bearish sentiment indicators for a look at what investors are seeing now. Fear has crept back into the market. See the bullish sentiment below which turned more cautious in mid-September:
According to CNN’s individual investor reading, Fear has indeed crept back into the market sentiment. See chart below:
Hedge funds are increasing bets against Discretionary stocks. The following chart shows that many of the more sophisticated investors (hedge funds) feel that consumer spending will continue to slow and negatively impact Consumer Discretionary Stocks. See chart below:
Now For Some Of The Positives.
Earnings projections for 2024 are being revised upward. As we have often stated, earnings are the engine that drives stock prices. While other factors including profit margins, revenue growth, and price versus earnings growth are important, at the end of the day if a company is delivering results better than expectations their stock price is likely to appreciate. See chart below:
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The data is clear. Inflation has dropped from above 9% last summer to 3.7% today.
It gets really interesting when you add a trendline to this bit of analysis. The Fed’s “ideal” target for inflation is 2%. And that trendline takes us right there. See chart below:
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According to Ryan Detrick of the Carson Group:
“The last 9 times the S&P was lower in both August and September saw Q4 close higher (back to 1981). Higher 9 for 9 and up 9.1% on average”
Now we turn it back over to Keith and his team and their Big View bullet points. Make sure you watch Keith’s video this week. Make it a good upcoming week and STAY SAFE OUT THERE!!! Thanks for reading.
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