Weekly Thoughts: August 7, 2023

August opened with an epic week of news and macro data. The S&P and Nasdaq tumbled four straight days, notching the worst week since March in the days after Silicon Valley Bank. The declines were 2.3% and 2.9% respectively for the week. Considering the recent extension of the rally, investors are wondering if it is the start of a more typical corrective move.?The market rise has been so strong that the distance above 50- and 200-day moving averages, often support targets in corrective moves leaves plenty of distance for a decline without violating the uptrend.

The major headline of the week was the downgrade of the US Treasury credit by Fitch. Most economists state that it is not a significant issue in the short term, but it is a warning to the political class both parties have behaved irresponsibly for the past two decades, and the clock is running on addressing long term issues. Some say Cassandras have been wringing hands about debts and deficits for years and all remains well. Our team’s response is that while we are not nearing the point of a debt crisis, excess debt is a drag on growth, and we have experienced below trend GDP since the GFC. We believe the debt overhang is the primary cause. Less GDP means the compounding of growth shortfall gets worse and the size of our economy today is significantly smaller than if we had returned to trend after the GFC like we did after prior recessions. Therefore, the idea that thus far excess debt “is not a problem” just isn’t so!

A bigger market development pertained to the rise in yields on the longer end of the curve. Short-term rates are driven by the Fed, but markets determine longer maturities and as you all know, we have had a severely inverted yield curve for over a year. While still inverted, market participants seem to be throwing in the towel on imminent economic decline. After the Q2 GDP 2.4% level, the 10 year and 30-year bond yields have moved significantly higher. The 10-year rose from below 4% to as high as 4.20% this week before dropping to end Friday at 4.04%, the first time above 4% since March. 30-year debt closed the week at 4.21% and had not been above 4% since the latter part of 2022. Higher yields are likely responsible for the sell-off in risk assets.

The economic data we entered last week believing would be the most important market mover came on Friday. Non-farm payrolls rose 187,000, slightly short of expectations but the unemployment rate did tick down to 3.5%. Average hourly earnings rose .4% for the month, ahead of the .3 consensus. The rise was 4.4% for YOY. In sum, this data series was solid enough to state the economy remains resilient but not hot enough for the Fed to get more aggressive. 88% of traders polled by the CME Group’s Fed Watch tool expect the Fed to pause at its September meeting. Next week’s CPI & PPI release may well adjust that result.

An excellent economic release was the result of preliminary non-farm productivity [output per hour] which increased at a 3.7% annual rate. This crushed the expected 2.2% and was the best result in over three years. Productivity is a major input for GDP, so this is most welcome in terms of solid growth figures. The cause was an increase in output while hours declined slightly.?The labor market remains tight and recessionary calls are in retreat. JP Morgan and many other securities firms have pulled the recessionary call for 2023, although they do caution that they remain wary into 2024 as the consumer is still pressured by tighter budgets, credit conditions are tough and excess liquidity should be dry by late 2023. Lastly, inflation may start to get tougher to decline from here and if the economy hasn’t rolled over, the Fed has room to continue tightening. The lag effect of these raises will go on for some time, which may be too much for consumers to overcome next year.