Dow Jones Industrial 34,346.90 -0.45%, S&P 500 4,405.71 0.82%
Nasdaq Composite 13,590.65 2.26%, US Ten Year 4.233%, Crude Oil $80.08
August’s rather unpleasant month for the financial markets. Despite today’s modest rally all the major stock indices are well down from their end of July highs. The Standard & Poor’s U.S. Government Bond Index also declined, over 1% as higher interest rates drove down the value of existing bonds (bond prices move inversely to interest rates). When chip giant and Artificial Intelligence favorite Nvidia Corp reported numbers that crushed estimates for both earnings and revenues the stock rocketed and pulled the rest of the tech sector up with it, but the rally ended abruptly as investors soon turned their attention to Fed Chief Powell’s presentation today from Jackson Hole.
The Chairman’s remarks were hawkish, but not excessively so. He issued the now standard comments such as the Board being dependent on the data and devoted to its 2% inflation target. The central bank’s preferred inflation measure, the Personal Consumption Index was 4.3% in July. Inflation concerns raised the interest rate on two-year treasuries to above 5%. The question does remain whether Fed action alone will be enough to tame inflation in the face of ever-increasing federal debt.
Corporate second quarter earnings were good, with almost 80% of firms meeting or beating estimates. According to data provider Refinitiv, Q2 2023 had the highest rate of companies beating expectations since Q3 2021. Revenue growth was disappointing, but if businesses can maintain and improve profit margins stocks should perform well once some of the uncertainty about interest rates subsides. From the chart below we see how strong earnings have raised future expectations.
At its current level the S&P 500 is trading at a price-earnings ratio of 18.6, not inexpensive by historical standards, but not overly pricey either. The chart below illustrates the inverse relationship between the Fed Funds rate and S&P 500 stocks. Note how increases in the risk-free rate in orange (right scale) led to stock market declines in blue (left scale), and how it correlated with recessions shown in gray. The huge sell-off in 2022 reversed at the beginning of this year as investors anticipated the end of Fed Fund rate hikes. That appears to be the situation now.
I recommend extending bond maturities now out as far as two years, where U.S. government securities are now yielding 5% and whose interest is free from state and local income taxes. Always “ladder” fixed income securities so that you can sell very short-term holdings to raise cash when stock market conditions turn more favorable.
Wishing You a Profitable Week