The Start of August….

August 7, 2023

“Bull Markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”

Sir John Templeton

Last week seemed to bear out all the elements of this quote, starting on a continuing run, with a quick reversal, then recovery, followed by ending the week down and having the worst week since March of this year. The S&P 500 was down 2.3%, Dow Jones Industrial Average dropped 1.1%, the Nasdaq fell 2.9%, over seas the British FTSE was the big winner, up .47%, and the MCSI-EAFE was down 2.98%. The 10-year treasury finished the week with a yield of 4.06% after swinging back and forth.

The big news last week was Fitch down-grading the United States debt rating from AAA to AA+, which prompted Chase Chairman Jamie Dimon to call foul and make the case that the US is still the world’s premier economy and ultimate safe haven. He noted,  “markets decide- it’s not the rating agencies that make these big decisions.”  Some would argue it was more political, however, given this government’s propensity to tax and spend the logic makes sense. Further, I will remind all that the US has lost the AAA rating before and somehow managed to survive, but it is a reminder the US still needs to take fiscal responsibility seriously. It’s worth noting Moody’s left their rating still at AAA.

Apple reported and Wall Street was underwhelmed despite a decent number, Amazon, on the other hand, had a very good quarter.  The jobs report was less than spectacular with the new jobs created coming in at 187,000 not the 206,000 expected by the consensus of economists.

The economists at Bank of America were the first to declare no recession anymore, expecting a soft landing (a nice way of saying no recession) and GDP growth of 2%. Speaking of economists, the collection of economists at major banks still show a recession as their base case. Economists at Morgan Stanley (MS) have always called for a soft landing, but Deutsche Bank (DB) predicts a mild recession that is likely to set in toward the end of this year. Wells Fargo (WFC) economists predict a recession in the first half of next year. Citigroup (C) sees a recession starting in the U.S. in the first quarter of next year. (Proving the age-old theorem that you ask 20 economists the same question and you get 20 different answers.)

There are plenty of reasons for caution. A Federal Reserve survey released on Monday showed that during the second quarter, banks tightened lending terms the most since early in the pandemic, which could slow the economy by making it harder or more expensive to borrow. This, coupled with the concerning increase in consumer spending and increasing personal debt loads could drive the inflation number when the piper needs to get paid.

Wendy Edelberg, director of the Hamilton Project and senior fellow in Economic Studies at Brookings Institution, commented “to get household finances and, indeed, the broader economy on a healthy track, goods spending-in real terms- just has to outright decline.”

Still, other economists can change their tune. “Our confidence in our recession call has come down,” Wells Fargo chief economist Jay Bryson told Barron’s. “Gun to our head, we still say yes [recession] is more likely than not,” but the probability is now 60% versus 70% three months ago.

One final comment on July’s excellent performance is that the data seems to show it was driven by investors’ risk-seeking behavior, typical in a rising market (see Sir John Templeton’s quote above), the safe stocks with low volatility underperformed.

That brings us to August, the first week demonstrated both extremes of opinion slugging it out.  Are the headwinds mounting? We think so, it seems the numbers are saying that the choice for consumers is stop spending or take on more debt-and in most cases expensive debt to rising interest rates- and they are currently choosing the latter. The hope is in the 3^rd quarter consumers get the message.

One thing is certain, volatility will remain, inflation is still a problem, just check the gas pump as the Saudis extended production cuts, continued reduction of the world supply last week caused a jump at the pump.  Reminding us all that the apparent decline is still well above the target inflation rate of 2% set as the Federal Reserve’s goal.

Despite the inevitable finger pointing and hand wringing in Congress, as the budget process moves ahead for FY24 and FY25, expect that will be standard operating procedure.

We continue to believe the bargains are in the small and mid-cap value sectors of the market and have weighted accordingly.  We will strategically move short-term fixed income positions into intermediate terms, this has been tough as the short-term rates north of 5% still look attractive.

This week, earning season continues which will confirm or call into question the broad breath of the market advance.

Mike