Market Update - November 2023 | |
Powerful water flows can carve a landscape like butter. Erosion is a natural process and part of life on planet Earth. The Grand Canyon is a superb example of water's power in action. Similarly, high interest rates erode an economy's ability to grow, carving out new channels of pain in the financial, consumer, and technology sectors. With most interest rates at 5%+, interest expense is damaging the underlying financial topography and moving things around. | |
- Stock and bond markets fell during October as interest rates raced up and down during the month. The bond market is getting nervous about runaway Federal spending and the Fed's unwillingness to slow economic growth. Third quarter nominal GDP recently was reported at an astounding 8.5%. At the same time, the housing market is weakening and cracks are starting to spread in the loan market.
- Last week technology companies Microsoft, Google and Facebook delivered poor earnings forecasts. This indicates economic weakness.
- Gold traded significantly higher in October as investors sought safety trades in light of the tensions between Hamas and Israel. Silver did not participate in this rally.
- Classic signs of recession are beginning to emerge:
- Falling home prices
- Rising bond defaults
- Weak corporate earnings
- Weak oil markets despite geopolitical tension
- The only recession signal that has not appeared is a rise in unemployment.
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Table 1: Market performance estimate as of 10/31/2023 (LIMW) | |
Investors are afraid of the budget gap | |
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In September, we did a deep dive on the US fiscal budget situation and explained why these trillion dollar deficits should not worry us for a few more years. However, it is still interesting to see some good research trying to explain why the deficit is turning sour in 2023.
In the graph below, you can see that deficit components are a blend of spending increases and revenue losses that contributed significantly to the widening budget gap this year. While higher interest rates are on everyone's mind, there are many factors contributing to the problem.
In our view, the economy is strong enough to carry the debt load. This may change 5-10 years out, but for now we are not concerned. If you would like to review our government debt research note, the link is here below:
LIWM September 2023 - Is the USA drowning in a tidal wave of debt?
Figure 1: Contributors to the 2023 budget deficit (US Dept of Treasury)
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Inflation continues to trend lower | |
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The inflation data continues to fall slowly. While there are fears it might increase going into 2024, the important Core Personal Consumption Expenditure (Core PCE) inflation edged down again last week. This is a good sign because the Fed follows this data point quite closely. The latest reading was 3.8% year-over-year.
Our view is that the Fed is done raising rates for this cycle. As signs of distress begin to emerge, we expect the Fed to begin cutting rates in 2024 as clear signs of recession and stress become unmistakeable.
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Figure 2: Core PCE inflation and Federal Funds Rate (LIWM) | |
One of these is not like the other
There was great hope that October 2022 was the bottom of the equity bear market and that the subsequent rally was the beginning of something really BIG!
Edward Jones has produced an intuitive comparison of historical bull markets and compared them to the October 2022 rally to see if they look the same. Notice how different historical bull markets are from the current experience.
Small caps and the equal-weighted index usually outperform in a sustainable bull market situation. In the current experience however, these two asset classes are underperforming. This is another data point indicating we are still in a bear market.
Figure 3: S&P 500, Equal-weighted index, & Small cap performance after a bear market low (Edward D. Jones)
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Long-term Treasury bonds weakened again in October as the critical benchmark 10-year Treasury bond yield poked above 5%. In Washington, there seems to be no concern or sensitivity to bond market worries that government spending is broadly uncontrolled. On this front, the Federal Reserve has little to no impact; if Congress and the President want to spend money, it gets spent.
Meanwhile, the Fed continues to slowly reduce its balance sheet which gradually increases the supply of US Treasury bonds in the marketplace. The fearful narrative is that the combination of Fed bond ownership reductions and Treasury bond sales will create a "doom loop" for the bond markets.
In our opinion, the economy and markets are sufficiently large enough to carry this load for now. In 10 years, the situation will be worse, but we don't have to make a 10 year decision today. Bonds are an asset class that can be bought or sold. There is no law that says we have to hold them to maturity.
The real question is what will the bond market do as inflation falls and the economy enters recession? Historically, these two situations create a good fundamental support case for owning bonds. There are some signs of capitulation selling in the bond market, which may indicate an end (for now) to the bond bear market.
Figure 4: Bond market price and volume indicate capitulation (LIWM)
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Capitulation selling shows up as a downward spike in price accompanied by a similar upward spike in trading volume. Down below, look at the confluence of high volume and low price in the stock market 2007-2010. It is possible the same pattern is repeating in the bond market? We think so.
Figure 5: S&P 500 capitulation during the 2009 bear market (LIWM)
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No capitulation in the stock market | |
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In the stock market, there are no signs of the capitulation we see in the bond market. The stock markets peaked about 3 months ago short of the 2021 all-time highs. Without a new high in July 2023, it is very difficult to make the case that a new bull market began in October 2022.
The October 2022 - July 2023 rally is starting to look like a bear market rally with the stock market is resuming its downtrend. Where might it go? Well, S&P 500 at 3400 looks very interesting. That is where the market peaked pre-pandemic, it is where the market bottomed in October 2022, and it is where uptrend support from 2009 exists. There is good support at that level and the bad news might just take us down there.
Figure 6: S&P 500 weekly 2018-2023 (LIWM)
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There is a difference between studying history and living it. It is easy to analyze a historical bear market like 2000-2003 and glibly point out the bear market rallies. However, for those living it, the experience was water torture because it happened so slowly.
We are living through a similar experience. There is no law that says this bear market should only be six months, twelve months, or eighteen months. Every bear market is different and there are multiple powerful forces at work in the markets today.
If you read our research, you know that we've been calling the current environment a "bear market rally". Bear market rallies are counter-trend moves that seem like bull markets, but later resume the larger bear market downtrend. The size and duration of this one were large, but not unprecedented. There were two 24%+ bear market rallies in 2002 at the end of that bear market, for example.
Figure 7: S&P 500 weekly 1998-2006 (LIWM)
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It is our view that the stock market completed a bear market rally in July 2023 and is resuming its downward path. The bond market, on the other hand, is showing signs of capitulation selling that may indicate an end to the bond bear market.
There may be a short stock rally over the next week or two. After moving down decisively, the stock market is oversold and due for a small bounce. That will be your chance to rebalance your portfolio, if needed. Call us if you don't know what that means.
We enjoy discussing our research and how it relates to your situation. Feel free to give us a call. It is important to consider your portfolio allocation as interest rates peak and the economy slows down.
We look forward to hearing from you!
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Rob 281-402-8284
Chris 281-547-7542
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Christopher Lloyd, CFP ®
Vice President and Senior Wealth Planner
Lloyds Intrepid Wealth Management
1330 Lake Robbins Dr., Suite 560
The Woodlands, TX 77380
281-547-7542
Chris.Lloyd@lloydsintrepid.com
www.lloydsintrepid.com
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