The futures market suggests a negative open to today’s stock trading. There is no major economic news due for release on this final day of the workweek. The domestic stock market indexes look to post losses of 2%-3% for the full week. This is proving to be a tough month for equities. So far, compared to their late-July highs, the blue-chip Dow Jones Industrial Average is off more than 3%, the broader Standard & Poor’s 500 index is down nearly 5%, and the tech-heavy NASDAQ composite has declined over 7%. Visible stressors in recent times included Fitch Ratings’ downgrade of U.S. government bonds, Moody’s downgrades of the debt of several regional banks, the end of a ho-hum corporate earnings season, higher-than-expected wholesale price inflation, and unfavorable economic readings from China.
We note that investors are attuned to trends in inflation and interest rates, affecting share prices. Lately, consumer spending has proven resilient, thanks to low unemployment and improved wages. Gross domestic product growth continues to be healthy, notwithstanding consumers’ and businesses’ heightened scrutiny of their spending budgets. Investors are concerned that, given a still-solid domestic economy, inflation could pick up in the second half of this year. Adding to the concern is reduced oil production by Saudi Arabia and Russia, which is supporting higher energy and distillates prices. Also, Russia’s bombing of grain export terminals in Ukraine point to potentially higher food costs down the road.
This coming week, fresh data, in the forms of existing and new home sales, purchasing managers indexes, jobless claims, durable goods orders, and consumer sentiment, will roll in. Aside from monitoring this new economic information, investors will be looking for anything of interest coming out of the Federal Reserve Bank of Kansas City’s Economic Policy Symposium in Jackson Hole, Wyoming, scheduled for August 24-26. According to the minutes of the Federal Open Market Committee’s previous meeting in July, when it raised short-term interest rates one quarter of a percentage point, to 5.25%-5.50%, a few central bank officials voiced their opinions that one other 25-basis-point hike may be in order before the end of this year. The consensus on Wall Street is that the Fed likely will not make such a move at its meeting in September, but another hike could be implemented in November or December, depending on economic trends.
The yield curve comparing short-term and long-duration U.S. government bonds has been inverted for quite some time. More specifically, short-term bond yields are higher than those of the long bonds. An inversion implies a recession is close at hand. Elevated short-term U.S. bond yields have prompted many investors to pull money out of the stock market to capture a favorable level of guaranteed bond income with very modest risk. Lately, long-term Treasury yields have risen, with bond investors seemingly thinking that interest rates will stay elevated for a while. (The expectation of the Fed cutting interest rates is getting pushed further out into 2024.) This current situation is referred to as a “bear steepening.” Investors (and banks) prefer a “bull steepening,” where short-term yields fall, while bond prices rise, and the yield curve becomes “uninverted.”
We are cautiously optimistic that a harsh recession will be avoided and that a “bull steepening” will occur. For now, we advise dedicating some 45% of investment portfolios to cash and high-quality bonds, while concentrating equities holdings in industry leaders within the energy, financial, healthcare, consumer staples, and industrial sectors. (Note: Technology company stock valuations are coming down to more reasonable levels, but they might have to endure some additional selling pressure in the near term.) - David M. Reimer
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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