September 2023 Market Perspective

Bill Hastie, Managing Partner |

The U.S. stock market fell in August, marking only the second month of declines this year, amid fears that the economy is showing signs of slowing.  The Dow had the largest decline at 2.4%, while the NASDAQ lost 2.2% and the S&P 500 fell 1.8%.  Counterintuitively, though, a late-month rally in the stock market was spurred by signs of cooling in the U.S. economy in hopes that a cooling economy would give the Federal Reserve (Fed) reason not to raise interest rates at their next meeting September 19 and 20.

September is off to a rough start and history shows that September is the weakest month of the year on average.  Since the peak on July 31, the S&P 500 and the “Magnificent 7” are down 2.7%.  Given the valuations of some of the Magnificent 7, analysts were concerned that if any one of them did not reach their earnings projections, the sector would suffer.  The relative value of a stock is often measured by its price/earnings ratio (P/E), and currently the P/E ratio of the market is about 22.  In recent weeks, the P/E of some of the AI-related stocks was approaching 200 – nearly 10 times that of the market.  Many analysts feel that a fall from grace is inevitable should actual earnings not reflect such rich valuations.

The market remains primarily focused on two things – inflation and future Fed actions.  As for consumer inflation, the Consumer Price Index (CPI) for August was released September 13 and rose 0.6% in August, the largest monthly gain of 2023.  Year-over-year, the CPI rose 3.7% from a year ago.    Economists surveyed by Dow Jones were looking for respective increases of 0.6% and 3.6%.  Core CPI, which strips out volatile food and energy prices, rose 0.3% when the market was looking for 0.2%.  Year-over-year, core CPI rose as expected 4.3%.  Fed officials focus more on core CPI as it provides a better indication of where inflation is headed over the long term.  Energy prices fed much of the gain in CPI, rising 5.6% on the month, and an increase that included a 10.6% surge in gasoline prices.

Taking a little deeper look at the August CPI report, there is some concern about advancing inflation in the short run.  What is known as the “super-core” CPI, which measures core services and extracting housing costs, rose 0.4% in August after an increase of only 0.2% in July and no increase in June.  “This (data) confirms a reacceleration” of inflation, says Kevin Gordon of Schwab Research.  But this uptick in inflation was widely expected both by the Fed and the market. “The aggregate of the CPI reports are close enough to expectations that the net impact on the market today will be fairly negligible,” said Mr. Gordon.  The good news is that consumer inflation remains trending downward on a longer-term basis. 

In recent weeks, remarks from Fed officials have indicated a more cautious approach ahead.  Before now, policymakers had preferred to overdo monetary tightening (hiking interest rates and federal open market operations).  They now see risks in the economy more evenly balanced and appear more cautious about future rate hikes.  “Overall, there is nothing here to change the Fed’s plans to hold interest rates unchanged at next week’s (Federal Open Market Committee) meeting,” wrote Andrew Hunter, deputy chief U. S. economist at Capital Economics.  CME FedWatch estimates there is more than a 90% chance that the Fed will not raise rates at their September 19/20 meeting.  Futures pricing, however, has been volatile beyond that meeting, with Traders putting a 40% probability of a final rate increase on the Fed’s October 31/November 1 meeting.

From a portfolio allocation viewpoint, analysts remain focused on the coming end of the Fed’s rate tightening cycle and a potential bond rally that has historically taken place at that point.  The Bloomberg Barclays U.S. Aggregate Bond Index, after posting negative returns in 2021 and 2022, is struggling again in 2023 with the rising interest rates and inverted yield curve.  Our bond allocations remain balanced between very short-term (or short duration) and intermediate term.  We have added global bonds to the overall bond allocation which has fared a little better than the all-U.S. bond holdings.

In terms of stocks, growth stocks continue to outperform value, while the large cap technology-based stocks continue to drive the lion’s share of S&P 500 and Russell 1000 Growth performance.  The Dow, for example, is up less than 5% YTD (through mid-September) while the Russell 1000 Growth has gained more than 30% this year.  This is causing a wide dispersion of portfolio returns because a portfolio can only hold so much S&P 500 and large cap tech stocks and must hold other asset classes in order to achieve prudent diversification.

At some point, and better sooner than later, the Fed will get inflation under control (not necessarily to 2% annual rate), stop raising interest rates and the Treasury yield curve will normalize and the stock/bond markets will return to historical norms.