September 26, 2023

The market this year has been supported by faster growth and lower inflation, which at a minimum has pushed out a widely expected recession and lent credence to the soft landing case.  In turn, that has fueled a growing consensus that the Federal Reserve (“Fed”) is finished with its tightening cycle.  The Fed, however, at its most recent FOMC meeting, communicated that it may not be done yet.   The Committee’s Summary of Economic Projections (“dot plot”) maintained its prior forecast for one additional +25 bps hike before year end, and more tellingly cut in half the amount of rate reductions previously forecasted next year from -100 bps to -50 bps.  The “higher for longer” takeaway triggered a further rise in bond yields and a decline in stocks.   Even though the bulk of the Fed’s monetary tightening is likely now behind us, what’s left is for the full brunt of that tightening to hit the economy.

Contrary to the past couple months, economic data over the past two weeks was disappointing.  Inflation reports were hotter than expected;  retail sales excluding gasoline were softer; and LEIs (leading economic indicators) declined for the 18th consecutive month.  Offsetting that, jobless claims fell yet again, confirming that the economy continues to show positive momentum.

Aggressive rate hikes, accelerating quantitative tightening, declining money supply, an inverted yield curve, declining leading economic indicators, and tightening bank credit all strongly suggest that a recession is likely just a matter of time.  We believe the consumer will soon be facing stiffer headwinds.  Excess pandemic-era savings are nearing exhaustion.  Student loan payments are set to resume.  Oil prices are rising once again, and job and wage growth is slowing.  Banks continue to tighten credit availability and consumer credit card balances are rapidly rising once again at the same time that the cost of that credit has significantly increased.

Earnings estimates appear to be rolling over again and are at further risk as economic growth and inflation slows, leading to disappointing revenue and margins. It is worth noting that the typical seasonal pattern produces downward revisions between August and October, which helps to explain why this is usually the most challenging period of the year for the stock market.

Near-term market headwinds remain and could lead to further market volatility ahead:  1) historically, September has been the worst trading month of the year;  2) stocks remain fully valued;  3) investor sentiment remains complacent;  4) consumer headwinds are growing; 5) earnings estimates remain at risk; and 6) rising yields make bonds a more competitive alternative to stocks.