August 2023 | Equity Commentary
Published on September 21st, 2023
The S&P 500 retreated -1.6% in August, which we would frame as a ‘breather’ following the 20.6% rise through the first seven months of the year.1 It would be difficult to argue that corporate earnings drove weaker returns – in the second quarter, S&P 500 companies delivered a positive 7.91% surprise in earnings and a 2.07% upside surprise for revenues (with 462 companies reporting). Year-over-year, earnings were down -6.02%, but this figure was 8% better than analysts were expecting at the beginning of earnings season, and it’s also worth noting that aggregate earnings were weighed down by pronounced weakness in the Energy and Materials sectors.2 Expectations for future earnings and revenues have been rising, reflecting optimism that Q2 or Q3 2023 could mark the trough of earnings declines in this cycle. The 10-year U.S. Treasury bond yield moved 15 basis points higher in August, but a closer look reveals that intra-month, yields climbed up to 4.34% – the highest level since 2007.3
We think the key story for capital markets in August was the yield curve shifting higher, driven mostly by the 10-year Treasury bond’s 15 basis point move. We believe yields likely rose due to a number of factors. First, the supply of long-term bonds appears to be increasing, which we believe is a byproduct of limited issuance during the debt ceiling standoff combined with rising deficits as big spending programs kick in. We think seasonality is a second factor – August tends to see lighter trading volumes, and lower liquidity levels can exacerbate moves in either direction. We also wrote last month about the Bank of Japan’s surprise move to loosen yield curve controls, which may have shifted some demand away from U.S. Treasuries.
While these are all meaningful factors driving yields higher, we think the important takeaway in August was that upward pressure on yields was likely driven more by growth than inflation – with the latter trending lower while expectations for growth moved upward. Consumer price index (CPI) data for July was relatively benign. The Labor Department reported that core CPI rose by 4.7% year-over-year, a slight cooling from June’s 4.8% annual rate. Month-over-month core CPI also showed signs of cooling, up just 0.2% from June to July. Another, perhaps more insightful look at core inflation is to consider the 3-month annualized rate, which in July came in at 3.1% – the lowest print in two years.4
While inflation trends lower, expectations for economic growth are moving in the other direction. As of September 8, the Atlanta Federal Reserve’s GDPNow tracker is projecting the U.S. economy will expand by 5.6% in the third quarter, and consensus that the U.S. is heading for a recession in 2023 has largely dissipated.5 It appears that some economists have pushed out recession expectations to 2024, while others have embraced the idea of a soft economic landing. Either way, given that a recession is typically defined by two consecutive quarters of economic contraction, a downturn in 2023 is likely off the table.
U.S. consumers have been powering the better-than-expected economic growth story. In the second quarter, the Consumer Discretionary sector produced +35.43% year-over-year earnings growth on +11.63% higher revenues (also the strongest showing among S&P 500 sectors). While improving revenues were largely expected, the earnings surprise of 21.23% marked a blowout of analyst expectations.6 An important driver of strong spending has been real wage growth. Over the past 12 months, average hourly earnings have increased by 4.3%,7 while inflation (CPI, including food and energy) has risen by 3.2% over the same period.8
A healthy jobs market is helping. August data from the U.S. Labor Department showed the jobs market moving in the direction the Fed wants (slightly weakening), while still remaining in overall strong shape. Nonfarm payrolls rose by 187,000 for the month, with downward revisions to June and July. All told, the three-month moving average increase in employment dropped to 150,000 jobs/month, which is more in-line with pre-pandemic norms.9 The number of job openings also fell from 9.16 million in July to 8.8 million in August,10 while a 736,000 surge in the labor force (0.2% increase) pushed the unemployment rate from 3.5% to 3.8%.9
The Federal Reserve’s annual economic symposium in Jackson Hole took place in August, and in it Chairman Jerome Powell acknowledged that GDP growth “has come in above expectations and above its longer-run trend.” He also pointed to strong consumer spending and the “incomplete rebalancing” of the labor market as possible risks to inflation, which “could warrant further tightening of monetary policy.” Chairman Powell struck a cautious tone, but he also seemed careful not to commit to further rate increases in this cycle. The market seems to think rate hikes are done, pricing-in a less than 50% likelihood of an increase at the next two meetings.11
An asterisk to the inflation and interest rate outlook could come in the form of higher crude oil prices. Last week, Brent crude closed above $90/barrel for the first time since November 2022, as OPEC members and Saudi Arabia announced that production cuts would be extended through the end of this year. Saudi Arabia’s production cuts were previously scheduled to end this month. Russia added to expectations for global supply tightness by announcing a reduction in exports through the end of the year.12 We believe the Fed tends to care more about core inflation figures, which strip out food and energy prices, but inflationary pressure in any form could put pressure on the Fed to respond in some way.
 Bloomberg SPX Index TRA
 Bloomberg SPX Index Earnings Suprise.docx
 Resource Center _ U.S. Department of the Treasury.pdf
 Consumer Price Index News Release – 2023 M07 Results.pdf
 GDPNow – FRBA.pdf
 Yardeni forward earnings and revenues as of 8-31-23.pdf
 August U.S. Jobs Report_ 187,000 Rise in Payrolls, Unemployment Rate Jumps _ Morningstar.pdf
 Consumer prices up 3.2 percent from July 2022 to July 2023 _ The Economics Daily_ U.S. Bureau of Labor Statistics.pdf
 BLS empsit.pdf
 Job Openings and Labor Turnover Summary – 2023 M07 Results.pdf
 Highlights of Fed Chair Powell’s Jackson Hole speech _ Reuters.pdf
 Bloomberg Brent Oil Hits $90 a Barrel After OPEC+ Extends Supply Curbs.docx
As of August 31, 2023