Dow Jones Industrial 35,281.40 0.62%, S&P 500 4,464.05 -4.78%
Nasdaq Composite 13,633.65 -1.90%, US Ten Year 4.158%, Crude Oil $83.04
Stocks took a second weekoff from the bull market that began in the spring. This has led to the question, is this is an end to the bull market, or merely a pause in prices that had simply gone up too far too fast? Most market analysts claim it is the latter. Brawny markets generally do retreat a bit after a rapid price rise. With the NASDAQ higher by over 30% and the S&P 500 by more than 16%, a breatherwas to be expected. Interestingly, the Dow Jones Industrial has lagged the other indices, up a modest 6%. That is indicative of a bull market being fueled more by lower expected interest rates than by economic growth, with companies in the fast-growingcommunications and technology sectors leading the S&P 500, with financial,health care, energy andutilities lagging.
Why is Consumer Discretionary doing so well in a slow growing economy? Some say it is the fall-out from the pandemic, with consumers spending funds they had not spent during the shutdowns, but I do not believe it. Consumer debt has reached an all-time high of $1.03 trillion. This spending is being fueled by credit. Meanwhile total federal debt has grown to more than $32 trillion. This debt must be serviced, and what happens with interest rates to manage this debt will be the leading influence for stocks over the near term.
Consumer Price Index and Producer Price Index figures released this week indicate that the lower interest rates many are hoping for may not materialize for a while, perhaps not until March 2024. The year-over-year CPI rose to 3.2%, higher than June’s 3% and the first year-over-year increase in 12 months. The monthly .3% rise in the PPI annualizes to 3.6%. If one has been closely watching rates, over the past two weeks they have seen both the two-year and ten-year climbing comfortably above 4%. Mortgages are often set against the ten-year and have climbed as well. The equity risk premium, which is an inversion of stock’s price to earnings ratio and represents stock earnings yield, is also set against the ten-year rate and moves against it inversely. With a current P/E of 21, the earnings yield is 4.76% and with ten-year rates at 4.09%, the equity risk premium has fallen to a modest .67%. Using a forward P/E of 19.7 based on 2024 expected earnings gives a not much higher ERP of .98%. These compare to the long-term average ERP of 4% going back to 1998, when Treasury Inflation Protected securities first became available. So, a temporary retreat in stock prices is no surprise. According to the CAIA association, Equity Risk Premiums are at a decades-long low:
Under this environment I recommend extending bond maturities within existing fixed-income portfolios to as far and one and one-half years, or March of 2025, where better than 5% is still available. But I am not suggesting increasing allocation to fixed income. Eventually the Equity Risk Premium should return to historical levels, and as such we believe stocks will continue to be the best hedge against inflation due to their long-term risk premium above inflation, and also because companies are able to pass along rising input costs over time to their customers.
A quick note, our heartiest congratulations to our colleague Marshall Burroughs, CFP, who has completed the rigorous coursework prerequisite to earn his certification as a Certified Financial Planner.
Have a Great Week