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WEEK AHEAD
September 25-29, 2023
Sowell’s technical signals were certainly weakened by last week’s market volatility but were offset by the better-than-expected fundamental leading indicators. Overall, the blended signals are cautiously holding ground for the time being in full position (100%).
Markets experienced another challenging week, characterized by what some refer to as the 'September Effect.' Multiple factors contributed to this downward trend, including ongoing union strikes, the upward trajectory of mortgage rates, crude oil prices reaching $90 per barrel, a congressional impasse over government spending deadlines, and, notably, the comments made by the Federal Open Market Committee (FOMC) last Wednesday regarding interest rates.
Equity markets bore the brunt of last week's turmoil, with a staggering 60% of the month's total decline occurring in just these past few days. The S&P 500 and Nasdaq Composite indices endured losses of -2.91% and -3.61%, respectively, resulting in month-to-date returns of -4.08% and -5.83%. The technology and communication sectors were particularly hard-hit, with declines of -2.83% and -3.22%, respectively, led by industry giants such as Microsoft, Google, and NVIDIA. Nevertheless, it's worth noting that both the S&P 500 and Nasdaq have held their ground with commendable year-to-date gains of 13.9% and an impressive 27.0%, respectively.
Compounding these challenges, last month's inflation reading stood at 3.7%, significantly exceeding the FOMC's long-term target of 2%. Consequently, the Federal Reserve's commitment to maintaining higher interest rates for a more extended period and the possibility of further rate hikes sent shockwaves through the financial markets. Bond markets and mortgage rates responded by hitting levels not witnessed since 2007, with the national average for 30-year fixed-rate mortgages approaching a staggering 7.9%. Meanwhile, 20-year and 30-year bond yields surged to year-to-date highs of 4.70% and 4.53%, respectively, resulting in the Bloomberg US Aggregate Bond index returning -0.24%.
A blend of pivotal economic indicators and pressing labor concerns will shape the financial landscape as we peer into the upcoming week. While crucial reports on housing, GDP growth, and consumer spending will certainly command attention, it's worth noting that the forefront will be occupied by the ongoing union strikes and their far-reaching implications for the economy. Amidst this backdrop, the imminent deadline for the government appropriations bills looms large, with the critical due date set for September 30. This deadline is a vital juncture, as it dictates the allocation of funds for various government programs and functions. The potential consequences of a failure to pass these bills on time include government shutdowns, which could have ripple effects throughout the economy.
"If the economy evolves as projected, the median participant projects that the appropriate level of the federal funds rate will be 5.6 percent at the end of this year, 5.1 percent at the end of 2024, and 3.9 percent at the end of 2025. Compared with our June Summary of Economic Projections, the median projection is unrevised for the end of this year but has moved up by 1/2 percentage point at the end of the next two years."
– Fed Chair Jerome Powell, FOMC Press Conference, September 20, 2023.
Funding the Government
"Markets can remain irrational longer than you can remain solvent." - John Maynard Keynes
Investors are looking past the potential for economic and capital market instabilities. The current price-earnings multiple for the S&P 500 on trailing twelve-month earnings is about 26. This compares to the long-term median multiple of about 15 times trailing twelve-month earnings.
Near-term optimism, driven by the Fed's largely successful effort to lower inflation, will be challenged by new threats to price stability and economic growth if current economic policies remain in place. The CBO estimates that the Federal Budget deficit for the current fiscal year will be about $1.5 trillion. If current budget policies and spending programs are not altered, the CBO expects an additional $21 trillion to be added to the current Federal debt outstanding over the next ten years. How will this debt be financed?
The Fed could buy the debt and increase the money supply once again. There are some early signs the Fed has stopped reducing liquidity as part of its effort to control inflation. The monetary base, which was declining, is now remaining stable in the most recent measurement periods. This trend leaves the base about $ 4.5 trillion higher than in 2008 when the Fed first began its mission to rescue the economy from a deep decline. Their effort to shed assets was interrupted by an economic collapse driven by policy responses to the COVID-19 pandemic. And now, the Fed may need to choose to maintain price stability or bail out the Treasury.
If the Fed does not step up and finance the debt, an effort to increase tax revenues by raising tax rates may ensue. Based on the data available since the federal income tax was instituted in 1913, raising rates will likely reduce economic activity in the private sector and produce tax receipts well below expectations; the deficit will increase. The most recent data show a decline in personal income tax receipts on a year-over-year basis. Raising tax rates will cause this trend to persist.
Arthur Okun, one of the original supply-siders, was an economic advisor to JFK and LBJ. He wrote:"High tax rates, are followed by attempts of ingenious men to beat them as surely as snow is followed by little boys on sleds."
Reducing the rate of growth of spending below the rate of growth of revenues is unlikely. The CBO has noted the primary drivers of spending include Social Security and Medicare. There is little or no political will to reduce the rate of growth of these entitlements, but Congress may be forced to reduce benefits. The latest report from the Trustees for SS concludes that SS will not be able to meet its obligations after 2036. At some point, benefits may be reduced as they were when the retirement age was raised to 67, or tax revenues must be raised, but in the near- term, neither of those actions is likely.
The Fed will be forced to choose, finance the deficits, or control inflation. The Fed has chosen the policy that raises inflation for the last 50 years. Since Nixon closed the Gold Window in 1971, the CPI has risen from roughly 40 to 304. The price of gold has risen from about $35 to just under $2000. Oil prices have risen from under $7.00 per barrel to $70.00 per barrel. It may take some time, but inflation will rise well over the Fed's target of 2%.
Advisory services offered through Sowell Management, a Registered Investment Advisor. The views expressed represent the opinion of Sowell Management. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and non-proprietary sources that have not been independently verified for accuracy or completeness. While Sowell Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sowell Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results.