September 2023 Market Update

At the September FOMC meeting the Fed signaled a pause to interest rates hikes but also suggested another rate hike is more likely than not before the end of the year. The resilience in the labor market thus far has surprised market participants. Chairman Powell delivered the message last week that a “soft landing” was not his base case, sending shockwaves through financial markets.

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Real interest rates are on the rise, the Fed is holding interest rate policy in restrictive territory, gasoline prices are rising and Americans are running out of post covid excess savings. These factors create a perfect storm for financial asset and real estate valuations.

Year to date the S&P500 is up +11.30%, the equal weighted S&P500 is up +1.23%, the Dow Jones is up +1.42%, the Nasdaq is up +33.6%, and the Russell 2000 is up +1.15%. Most of the equity market indexes are underperforming T-bills and cash held in money market funds earning +4-5%.

Earnings are high risk here with estimates expecting $225 for 2023, $250 for 2024 and $270 for 2025. Earnings on an annualized basis have already begun falling from $208 in 2021 down to $197 in 2022, as interest rates began rising. With much higher rates today, we believe these estimates are fantasy.

We continue to believe that a U.S. recession has likely already begun. Weakness in the labor market in the form of job losses will eventually come to fruition and apply downward pressure to a decelerating economy and financial asset valuations. Our goal is to be patient and collect interest on cash until premiums on asset valuations such as stocks and real estate turn into discounts.

We feel interest rates are near their peak as we expect to see economic weakness (below trend GDP) from a restrictive rate Fed policy apply downward pressure to the labor market and nominal interest rates.

Our recommendation since January has been to position portfolios to endure a recession, in a defensive manor, risk off and in cash, T-bills, money market funds, fixed income duration extended in September from 0-5 year to 0-30-year U.S. Treasury bills and notes, 10-year minus 2-year yield curve re steepening and select low duration U.S. equities. We remain patient.

Disclosure: Investing involves risk, including the possible loss of principal and fluctuation of value. Past performance is no guarantee of future results.

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