2023 | 3rd Quarter

Markets have been on a roller coaster ride this quarter. Strong markets throughout the first half of the year continued into July, but gave way to a bumpy August and September, driven by softening technology stocks and recession worries. Further compounding the situation, three of our major trading partners China, Japan, and Germany faced economic challenges. China is clamping down on tech innovators at a time when its economy is slowing, and its financial system is showing cracks particularly in real estate. Along with Japan’s economy slowing and Germany in a recession, reverberations ripple around the globe. Another cause of angst is the U.S. budget negotiations, resolved with a short-term Continuing Resolution on September 30th, but only funding until November.

S&P 500 earnings expectations have remained remarkably strong even with higher interest rates and uncertainty. In the third quarter, the S&P 500 returned a negative 3.27%, but remained up over 13% for the year. Small and mid-cap stocks lagged the S&P due to their greater vulnerability to higher rates and economic slowdowns. International markets were also negative with developed markets down 4% and emerging markets down roughly 3%.

While we were hopeful that rates would fall in the latter part of 2024, the message from the Federal Reserve’s Jackson Hole meeting in August was not encouraging. That said, investors are finding short-term Treasury yields of 5% as a risk-free alternative to stocks, putting more pressure on the equity market.

The Magnificent Seven – Tesla, Apple, Amazon, Alphabet (Google), NVidia, Microsoft, and Meta –continue to lead the market. While some gains were shed in August and September, we see no major rotation out of these sectors yet. Technology and Communication Services represent 35% of the S&P 500, which we consider to be a heavy concentration risk, making the case for our ongoing emphasis on diversification and remaining committed to shares of high quality financially strong companies.

Our main themes going forward: Federal Reserve policy; the inflation forecast; and the outlook for a recession.

Fed policy- The Fed’s deliberations in July had most members anticipating one more rate hike in 2023, given the ongoing strength in the labor market. The Fed voted unanimously to increase the benchmark federal funds rate by 25 basis points, a 22-year high, with Chair Powell stating, “We remain committed to bringing inflation back to our 2% goal. No one should doubt that.” We believe the Fed will keep interest rates higher and for longer than most market participants believed at the start of the tightening process. Interest rates remained historically low since the end of the 2008-2009 financial crisis. Coupled with the immense stimulus enacted during the pandemic, these low rates and a strong economy created the highest inflation in decades. We do not anticipate rates coming down anytime soon: with Fed officials projecting a target rate of 5.1% at the end of 2024.

Inflation – Inflation has come down from its peaks last year. However, prices and inflation remain above the Fed’s targets. The Fed’s policy tools (interest rates and the quantitative easing programs) are helping to push inflation down, but the massive stimulus spending from government, robust consumer spending and increasing energy prices have blunted these efforts. The resumption of student loan payments and higher rates on consumer loans should dampen demand but will take time to reflect in the economy.

Recession outlook – This is the most predicted-but-not-yet-happening recession ever. Though Congress just agreed to fund the government through November 17th, some spending will likely be curtailed. Deficit spending, roughly $2 trillion this year, is a big part of the problem, with higher interest rates on debt putting additional pressure on the economy. Declining tax revenues from capital gains, resulting from last year’s abysmal market performance, are another contributor.

Meanwhile, businesses are paying higher costs to borrow, and higher rates on auto loans and mortgages are taking a bigger bite out of consumers’ paychecks. The restart of repaying federal student loans (while contributing to declining inflation) may mean fewer dollars spent on consumer goods. This data supports a recession, though most economists predicting a recession think it will be a soft landing and will occur sometime in 2024.

Offsetting those predictions is the stable employment picture and the ongoing resilience of corporate earnings. Unemployment remains under 4% and while S&P earnings have softened, they remain ahead of previous expectations. Wall Street is bearish, which we view as a contrarian indicator that things may not be as dire as predicted. Manufacturing, which has been slumping all year, improved lately, and a recent Bloomberg survey of economists showed fewer are predicting a recession at all.

What it all means – Despite the volatility in the stock market coupled with a higher-for-longer interest rate outlook, stocks do not appear overly expensive. The consumer shows little sign of backing off and companies continue to hire. Concerns remain in the banking sector and the effects of the weakness in the commercial real estate market. If a recession is in the offing, we predict sometime in 2024 and it will hopefully be mild.  

The best defense against market volatility is a portfolio comprised of healthy asset allocation, and an emphasis on quality in both equities and fixed income investments.

As always, feel free to contact us with questions.

Jonathan F. Kolle, CFA®
President, Chief Investment Officer

Daniel A. Morris, M.S.
Co-Chief Investment Officer

Joseph K. Champness
Director

Shawn R. Keane, CFP®
Vice-President

Cindy de Sainte Maresville, CFP®
Certified Financial Planner

Rusty Giles
Director of Marketing

James V. Kelly, CFA®
Director

The foregoing content reflects the opinions of Smithbridge Asset Management and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct.

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