Given all the events in motion with the economy and markets these days, on an occasional basis we will continue to provide some brief perspectives from our investment team’s vantage point on market trends for our Napier newsletter readers.
Here’s some responses to questions we’ve been fielding recently:
What’s changed from your last piece in early June?
Quite a bit, as it turns out, although that’s nothing new for the stock market. In June we had mentioned concerns about the lack of broad market sector participation, as well as our expectation for the market to take a breather after the sharp run-up in prices into mid-year. While participation did broaden briefly for a few weeks, the big story became the run-up in the 10-year bond yield, which threw (and continues to throw) cold water on the stock market rally. Combined with the historically seasonally weaker months of August and September, this has created headwinds for markets.
Why is the 10-year Treasury bond yield rising and why is that important for the stock market?
There are several reasons. Inflation, while cooling, still remains persistently high; energy prices, an important inflationary ingredient, are at an 11-month high and in an upward trajectory; to finance its growing deficit, the government is selling more Treasury debt; and due to inflation concerns and a surprisingly robust economy, the Fed has indicated rates will remain higher for longer than markets have anticipated. Simplistically speaking, the context here for equities is inflation affects purchasing power and may hamper consumer spending, which has the ability to impact corporate earnings and higher bond yields can represent competition for equities.
What’s the outlook for further interest rate hikes?
While the Fed has indicated one more rate hike before year end is likely, the market, according to the Fed Funds futures, believes they are done with hikes. We’d note the Fed is data-dependent, so taking a wait and see approach would be best. However, the bottom line is even if there were a hike sometime down the road, the cycle of rate hikes is almost certainly nearing an end. That is a positive. On the other hand, the market has pushed back the possibility of rate cuts until July of 2024, so conditions will still remain tight for many months ahead. The next couple of weeks will provide significant clues on the direction of Fed policy with Friday’s important employment survey and CPI numbers the following week.
What’s your view on the 4th quarter?
As I’m sure many of you are aware, I used to be in the stock trading business for a good portion of my adult life. It can be a humbling occupation because markets can behave irrationally. That’s a long way of saying making short term predictions about the market direction is akin to a coin flip. However, I’d venture to say that I believe we’re a lot better off than at the beginning of 2022. So, personally, I’m optimistic and don’t believe that the light at the end of the tunnel is a train coming our way. The Fed has made slow but steady progress on the inflation front, the labor situation has become more balanced, supply chains are normalizing, and it’s possible this much maligned Fed may be steering us towards a “soft landing”, something only one other Fed administration has done post WWII.
With markets well off their highs for the year, we’re seeing pessimism out there. That can be a good contrary indicator for a rally. Also, if you believe in this stuff, seasonally the 4th quarter tends to be the strongest for the market. Earnings begin late next week and could be a catalyst. We’ll see…
What would make you nervous?
Well, as my wife or anyone in the office will tell you, I’m always nervous. But when I look at the macro environment, I think if the 10-year yield (currently 4.68%) crossed the 5.25% threshold, a level last seen in June 2007, that would present a problem for markets. We also watch yield spreads between riskier bonds and Treasuries. Those spreads have been behaving quite well, but if those widened considerably, it could be a sign of financial distress that might be a harbinger of an upcoming recession. Another wildcard could be something geopolitical, but these things are difficult to plan for.
If you have any additional questions or wish to discuss our investment outlook further, please contact Nick Berlen to schedule a meeting with a member of Napier Financial Team. (firstname.lastname@example.org; 781.884.2355).
Financial planning and investment advice offered through U.S. Financial Advisors, a registered investment advisor