by Alex Harding, CFA
Vice President, Equity Research
As we enter the final stretch of the college football season, the quote, “Not so fast, my friend,” from ESPN’s College GameDay analyst Lee Corso, accurately captures the week’s capital markets events. After a weaker-than-expected October jobs report and the U.S. Federal Reserve leaving rates unchanged, investors are confident the Fed is done raising interest rates and have quickly shifted their sights to the first rate cut. In response, stocks rallied over 5%, with the S&P 500 posting its longest daily winning streak since November 2021.
Following the Fed meeting last week, Chairman Powell acknowledged that financial conditions have tightened significantly in recent months. Central bankers must proceed carefully as the U.S. economy has yet to feel its restrictive policy stance fully. While interpreted as bullish for stocks and bonds, Fed officials did their best “not so fast, my friend” to temper investors’ expectations. At the International Monetary Fund’s annual conference on Thursday, Powell said getting inflation down to 2% “has a long way to go,” and the Fed “won’t hesitate” to raise interest rates again if necessary. With inflation not fully tamed and a still tight labor market, the Fed’s pushback may be warranted despite the economy finally showing signs of slowing.
We believe longer-term interest rates are at or near their peak but do not expect them to return to the ultra-low levels seen at various times over the past decade. With bond yields compelling again, stocks have a worthy competitor. These dynamics pressure equity valuations and leave the onus on corporate earnings to carry stocks higher. As shown in the chart below, the stock market is currently valued at 18 times forward earnings, which is slightly above its historical average and based on estimates for earnings to grow 10% next year. The economy must avoid a hard-landing scenario to achieve this earnings growth level. As such, we recently reduced our equity exposure in balanced accounts.
Data as of 9/30/2023
Source: Refinitiv
Continuing the theme of corporate earnings, the third quarter earnings season is nearly wrapped up – with only a handful of retailers and software companies yet to report results. Fortunately, S&P 500 earnings have surpassed Wall Street estimates by 7% and are expected to grow by 5% compared to a year ago. Much of the strength can be attributed to improving profit margins as supply chain pressures and expense controls flow to the bottom line. Although earnings have positively surprised, stock price reactions have been subdued compared to the five-year average due to cautious guidance from management teams as the economic climate remains uncertain.
Takeaways for the Week
Fed speakers pushed back on the notion of interest rates being cut early next year as they remain steadfast in their fight against inflation
We believe long-term interest rates are near their peak and bond yields are (finally) compelling
Weekly unemployment claims remain stubbornly low but continuing claims are rising – implying it is becoming more difficult to find a new job as the labor market cools