September 2023 | Equity Commentary
Published on October 11, 2023
Equity markets behaved in September much like they did in August, with interest rates going up and stocks going down. The yield on the 10-year U.S. Treasury bond rose from 4.11% to 4.57% in September1, a larger increase than was seen in August and which also resulted in a bigger downdraft for stocks. The S&P 500 fell -4.8% for the month.2 Looking at August and September together, 10-year Treasury bond yields rose 61 basis points while stocks fell -6.3%.2 Generally speaking, higher yields give investors more choices for pursuing risk-adjusted returns, while also reducing the present value of future profits. Both outcomes tend to be negative for stocks, particularly in the high-valuation and high-growth categories. We believe the upshot in the current environment is that data strongly suggests the key driver of higher yields is better-than-expected economic growth, not higher-than-expected inflation. The latter would indicate that rates are rising for the wrong reasons, and also that the Federal Reserve would have no choice but to keep pushing rates higher in the future (which would create sustained pressure on stocks). It appears with inflation trending lower and the Federal Reserve no longer convinced a recession is necessary for controlling prices, there’s still a good argument for a decline in rates next year.
Many signs point to strong economic growth in the third quarter. According to the New York Federal Reserve’s August SCE Household Spending Survey, households spent 5.5% more in August 2023 than in the same month last year, and more households reported making one large purchase over the previous four months. Earnings reports and other survey data also indicate that Americans have yet to pull back from spending on experiences, like taking trips, buying concert tickets, or splurging on vacations.3
We believe US consumers’ willingness to spend is largely tied to ongoing strength in the jobs market. In the week ending September 23, weekly unemployment claims were 204,000, which is a historically low figure and also marks a solid improvement from data over the summer.4 Americans are also quitting jobs at a much lower rate than they were last year, with the ‘quits rate’ falling to 2.3% in August from a peak of 3% in April 2022. While it is true that the quits rate historically falls during a recession – as workers cling to their jobs – today it seems more tied to better pay, more flexibility, and a general sense that it may be challenging to get an even better job.5
Factory activity in the U.S. also improved in September. S&P Global’s manufacturing PMI for September 2023 was 49.8, which exceeded August’s 47.9 and is very close to returning to expansion territory. Output rose at a marginal pace but was the fastest since May. The Institute for Supply Management (ISM) gave a similar readout for U.S. manufacturing, registering at 49% in September from 47.6% in August, with improvements in New Orders and the Production Index.6
In Services – a more important factor in determining total U.S. economic output – S&P Global posted Services PMI at 50.1 in September, which remains in expansionary territory. S&P Global’s report indicated that business activity was largely consistent with August, though new orders fell amid weaker domestic and foreign demand. Companies did continue hiring at a solid pace, however, given strong output expectations looking ahead to 2024.6 ISM’s Services PMI looked stronger, registering 53.6% in September and showing solid increases in the Business Activity and New Orders indexes.7
While the economy demonstrates fundamental strength, inflation has continued to trend lower. In August, core CPI (which strips out food and energy) was up 0.3% from July and 4.3% year-over-year, a solid improvement from July’s 4.7% print. Importantly, when core CPI is looked at over a 3-month period, it increased at an annual rate of 2.4%, which is a substantial improvement from the 5% annual rate recorded over the previous 3-month stretch. 2.4% is also approaching the Fed’s target for inflation, a positive sign. The Labor Department reported that half of August’s headline increase in consumer prices was due to gasoline, which arguably keeps the Fed from becoming too worried, and supports a ‘pause’ of rate increases at the next meeting.8
Looking ahead to Q4, Federal Reserve Chairman Jerome Powell summed up many of the concerns playing out in the headlines, when he said: “It’s the strike, it’s government shutdown, resumption of student loan payments, higher long-term rates, oil price shock.”9 While each of these factors in a vacuum would not appear to be much of a concern for the broad U.S. economy, it’s the combination of all four that could serve as a headwind to growth as we approach the end of the year. We concede that these factors could make growth more muted in Q4, but we also believe the strength of the jobs market and the U.S. consumer are likely to continue acting as a neutralizing force, as they have all year. From an investment standpoint, the aforementioned headwinds are widely known and reported, which we think reduces their potential to negatively impact equity markets.
Sources
1.Bloomberg USGG10YR Index
2.Bloomberg SPX TRA Index
3.Americans Are Still Spending Like There’s No Tomorrow – WSJ.pdf
4.DOL Unemployment Insurance Weekly Claims News Report
5.Americans’ Growing Reluctance to Quit Their Jobs, in Five Charts – WSJ.pdf
6.S&P Global US Services PMI
7.September ISM World.pdf
8.U.S. Inflation Accelerated in August as Gasoline Prices Jumped – WSJ.pdf
9.U.S. Economy Could Withstand One Shock, but Four at Once_ – WSJ.pdf
As of September 30, 2023
