August 28, 2023
“The market can move for irrational reasons; you have to be prepared for that.”
The bond king.
After last week’s whipsaw market this quote seemed appropriate. The S&P 500 jumped all over the place, finishing the week at +.53% up, breaking a 3-week slip, the Dow Jones industrial average followed suit also gaining on Friday but off slightly for the week. The Nasdaq added .94% and the winner was the FTSE 500 gaining 1.05%. The broad international MSCI-EAFE was off slightly .11%. The 2-year treasuries finished with a yield of 5.078%, and the 10-year closing yield was 4.2342, continuing the inverted yield curve.
Politically, the main measure that any president has about the state of the economy is: how are middle-class families doing? The question is answered by where inflation (cost of living) is, interest rates (both on borrowing and rates paid on savings), and the general welfare of the public (crime, safety, school performance etc.) Despite the media attempt to paint a positive spin, the reality is in the effect these factors have on middle America.
All eyes were on Fed Chairman Jerome Powell’s remarks while speaking at an economic conference in Jackson Hole last Friday. Though he seemed pleased with the progress on inflation he still held a cautionary tone on future rate increases, but for whatever reason the markets like his “tone” and rallied on Friday ending a tumultuous week in positive territory.
As Barron’s Megan Leonhardt commented: “[h]e didn’t offer much in terms of the Fed’s outlook, either, and kept all options on the table, noting the FOMC will ‘proceed carefully’ and assess the totality of incoming data, as well as the evolving outlook and risks. His clearest point: The Fed won’t deviate from its mission to bring inflation back to a 2% target. ‘Two percent is and will remain our inflation target,’ Powell said, silencing any further chatter from economists who have questioned increasing the target.”
My much-watched leading economic indicators were again down for the 16th month. Which has me wondering when we will have to pay the check for all the good times so far this year. August proved to be the summer cooling off period after a hot July. Funny, if you been outside, that seems like a ridiculous statement. So far this month, the S&P 500 was off 183.25 points or about 4%.
Should his (Powell’s) comments cause another move higher in bond yields then growth stocks may be expected to suffer, providing another reason for investors to consider switching to value, a move proposed by Vanguard’s Capital Markets Model research team led by Kevin DiCiurcio and, at the risk of getting a bit to technical, we agree with the following assessment:
Vanguard defines value stocks as those with lower prices in relation to their enterprise book or accounting values, lower expected and historical growth rates and relatively high dividend yields.
Crucially, Vanguard says that the relationship between value and growth is currently at an extreme level, very similar to that seen in 2020. “Now, as then, investors in aggregate are very enthusiastic about growth stocks—notably, technology shares—and seem to have limited interest in value stocks, including financial, industrial, and health care companies,” says DiCiurcio.
Such extremes usually provide contrarian opportunity. The chart below shows Vanguard’s estimates of the fair value of value stocks relative to growth stocks.
On the inflation front, the persistent real inflation rate and the fact that real income has not caught up is now showing itself in old fashion disgruntled labor.
As Al Root of Barrons writes, in a move that should surprise no one, the United Auto Workers voted overwhelmingly to authorize a strike against Detroit automakers. The existing labor deal expires in mid-September and negotiations are ongoing.
“Our union’s membership is clearly fed up with living paycheck-to-paycheck while the corporate elite and billionaire class continue to make out like bandits,” said UAW President Shawn Fain in a Friday news release. “The Big Three have been breaking the bank while we have been breaking our backs.”
The supreme irony is that it is doubtful the rank and file will authorize the strike simply because they can’t afford it.
Another key point of pain for the middle class is U.S. mortgage rates increased for the fifth week in a row, with the 30-year reaching the highest level since June of 2001. The 30-year fixed-rate mortgage averaged 7.23% as of Aug 24, according to data released by Freddie Mac on Thursday. A year ago, the 30-year was averaging at 5.55%.
The average rate on the 15-year mortgage rose to 6.55% from 6.46% last week. The 15-year was at 4.85% a year ago. What Freddie Mac said: “Indications of ongoing economic strength will likely continue to keep upward pressure on rates in the short-term,” Sam Khater, chief economist at Freddie Mac, said in a statement.
Industrial production? Big picture: Perhaps the industrial side of the economy has hit bottom, and perhaps it hasn’t. Getting a clear picture probably will have to wait until interest rates stop rising.
Higher borrowing costs typically stunt the economy and discourage businesses from hiring, spending and investing. Looking ahead: “Businesses are showing caution amidst the higher rate environment and what it means for demand down the line,” said economist Ali Jaffery at CIBC Economics
We have made a few moves by selling a disappointing Oakmark International Fund (OAKIX), our long time holding which seems to have fallen on hard times and replaced it with Schwab Advantage International Fund (SFNNX), a 4-5 Star performer both short and long term. We still believe the value remains in the international large cap and in domestic value stocks. Additionally, we will continue to move bond investments to a little longer maturities as yields improve.