A Rocky Month
Quick Take: The Fed signaled continued restrictive monetary policy, prompting bond yields to continue their rise (prices fell). Equities turned in their worst monthly performance for the year, and the US government narrowly averted a shutdown.
For over a decade since the Great Financial Crisis, an era of near zero-interest rates spawned the mantra TINA “there is no alternative” to stocks. Now, with higher interest rates, the gap between the S&P earnings yield (which shows company earnings received for each dollar invested) and benchmark 10-year Treasury yields is the narrowest it’s been since 2005. That shift is a sign that investors have compelling alternatives to equities.
One of these alternatives comes from the yield on bonds. Last month, we discussed an increase in longer-term bond yields, a trend that persisted in September. The 10-year Treasury, a key reference rate for loans like mortgages and car loans, experienced its largest monthly jump in a year and hit its highest level since 2007, ending the month at 4.58%, up from 4.09%.
The surge in bond yields gives investors an opportunity to earn returns in the bond market with potentially less risk than the stock market, which helped push stocks lower.
What caused the sharp selloff in bonds that spilled over into stocks? The likely culprit was the Fed.
US stocks had been essentially flat heading into the central bank meeting Sep 20-21, but turned lower after officials signaled they might hold rates near current levels through 2024. The S&P and Nasdaq ended September down 4.9% and 5.8% respectively. Heading into the final quarter, the S&P 500 still boasts a 12% performance for the year, while most other market indexes are flat to down year-to-date.
As expected, the Fed didn’t hike interest rates in September but sent a hawkish message with a clear bias toward more restrictive monetary policy.
Along with sharply revising up economic growth expectations for 2023, the Fed released projections that estimate one more rate hike before the end of the year, followed by two rate cuts in 2024, which is two fewer than previously projected in June.  That would leave the target fed funds rate around 5.1%.
Fed Chair Jerome Powell noted that the change comes more from optimism about economic growth rather than inflation concerns, though he’d still like to see more progress in the inflation fight.
Inflation progress was validated by the central bank’s preferred inflation measure, the personal consumption expenditures price index, which showed the slowest monthly increase since 2020 in August. The job market is also resilient, with the low 3.8% unemployment rate barely changed since March 2022.
Another sign of job market strength is the increase in major strike activity, helping unions demand better pay and benefits. Strikes with at least 100 or more strikers that have lasted a week or more rose to 56 in the first nine months of the year, up 65% since 2022.
Strikes have occurred across industries. After five months on the picket line, the Writers Guild of America has just reached a deal, winning improved wages and job protections. The SAG-AFTRA that represents actors remains on strike but has returned to the bargaining table with Hollywood studios. In healthcare, a coalition of Kaiser Permanente staff are scheduled to go on strike for three days.
Mid-September, the United Auto Workers launched unprecedented, simultaneous strikes at GM, Ford, and Stellantis assembly plants. At the moment, only about 25,000 of the UAW’s 146,000 members are on strike, though the UAW has continued to expand numbers to apply pressure on contract negotiations. Lost wages, lower spending, and potentially higher auto costs are potential consequences of the strike, though the severity depends on the length and scale of strikes.
Moody’s Analytics chief economist Mark Zandi estimates that a full-scale UAW strike that lasts six weeks could reduce annualized 4th qtr GDP growth by 0.2%, which is small but meaningful given other potential headwinds from higher rates and gas prices.
The overall impact on the macro economy from strikes may end up being small – just 6% of private sector workers belonged to unions in 2022, which is a record low. Given the substantial rise in inflation that preceded union activity, these strikes probably should not be a massive surprise.
Government Narrowly Avoids Shutdown
Labor strikes weren’t the only source of potential disruption – the government faced a looming shutdown as funding was set to expire at the end of September. Passage of a funding bill was so uncertain that Goldman Sachs put the odds of a government shutdown at 90%.
On the final day Congress had to work out a solution, they passed a bipartisan agreement to keep the government funded until November 17. This makes a near-term government shutdown still possible, and we can probably expect more political wrangling ahead as we have seen discord throughout the political parties.
Markets made it out of a historically tough month with a few remaining headwinds. Although the economy has held strong over the summer, monetary policy operates with a lag, and its full impact probably won’t be felt until the end of this year or early 2024. Oil prices hit 10-month highs, and after a three-year pause since the pandemic, millions of student loan borrowers start accruing interest costs again and resume student loan repayments in October. The Fed meets again November 1-2 where another rate hike is on the table and bond yields could still go higher.
As we navigate the uncertainty, we have the benefit of perspective gained while managing portfolios through numerous economic cycles. With a disciplined, long-term investment plan, we avoid the pitfalls of reacting to continuous news flow or the urge to time the market (which usually does not end well). As always, we are happy to discuss the markets, our approach, and your portfolio with you – now is a good time to schedule a year-end review. Hope you enjoy a bewitching October with treats (and maybe a few tricks)!
Your Friends at JSF
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The Bloomberg Barclays U.S. Aggregate Bond Index measures the investment-grade U.S. dollar-denominated, fixed-rate taxable bond market and includes Treasury securities, government-related and corporate securities, mortgage-backed securities, asset-backed securities and commercial mortgage-backed securities.
The S&P 500 Index is an unmanaged, market value-weighted index of 500 stocks generally representative of the broad stock market.
The Nasdaq Composite is a market-capitalization-weighted index consisting of all Nasdaq Stock Exchange listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds or debenture securities.
Treasury Bond- is a U.S. government debt security with a fixed interest rate and maturity between two and 10 years.
Gross domestic product (GDP) is a monetary measure of the market value of all the final goods and services produced in a specific time period. GDP is the most commonly used measure of economic activity.
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