by Shawn Narancich, CFA
Executive Vice President Equity Research and Portfolio Management
Moving in the Right Direction
We have consistently messaged our belief the Fed would accomplish its goal to bring inflation down to 2%, and this week’s latest reading on its preferred measure of the price level supports our thesis. The core version of the personal consumption deflator moderated again in the August reading, rising 3.9% from last year’s level, in line with expectations and moderating from the 4.2% increase registered in July. Amid our central bank’s aggressive efforts at hiking short-term interest rates by over five percentage points since last spring, retail sales growth has moderated, the supply and demand for housing has diminished and the overheated labor market is beginning to cool.
Under Pressure
Collateral damage from higher rates, while so far sparing the ongoing economic expansion, is beginning to weigh on stock prices, as major U.S. equity indices logged low single-digit losses for the just completed third quarter. Higher interest rates weigh on stock prices because bonds made cheaper by higher yields vie for added investor attention, and because companies’ cost of capital goes up, negatively impacting corporate profits and how investors value such profits. As it turned out, September lived up to its historical billing as the only month with negative average monthly equity returns. With the benchmark 10-year Treasury yield ending Q3 above the 4.5% level, taxable bond returns moved into the negative column year-to-date. In a nutshell, both stock and bond prices fell in the third quarter.
Deja Vu
As investors reflect on diminished year-to-date returns in their investment portfolios, the potential for another U.S. government shutdown is garnering notable headlines. The chart below shows that while attention grabbing, such events are generally not economic or capital market moving events; if anything, they have coincided with positive average rates of return for equities.
Disagreements about funding the federal government for the fiscal year ending September of 2024 revolve around funding for the ongoing war in Ukraine, the southern U.S. border, and the ongoing excess of U.S. spending in comparison to tax revenues, the totality of which continues to generate budget deficits exceeding $1 trillion annually. If Congress is unable to pass bills funding the government for the next fiscal year by midnight Saturday, government employees deemed non-essential will be furloughed and corresponding portions of government will shut down. History tells us that the posturing and discord will continue until politicians feel enough pressure from their constituents to reopen government agencies, even if they kick the can down the road with continuing resolutions to spend at previously legislated levels. In the meantime, investors could be excused for yawning at the latest histrionics in D.C.
Earnings Season Ahead
With the third quarter now complete, Wall Street will be refocusing on another round of corporate profit reports anticipated in the coming weeks. As currently forecast, investors expect third quarter earnings to flip back into the growth column, with aggregate profits for the S&P 500 expected to rise by 1.5%.
Takeaways for the Week
Stocks and bonds fell, extending September declines and leaving returns in the minus column for the third quarter
History tells us that a government shutdown, if it occurs, is not an economically impactful or market moving event