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Volume 12, Edition 27 | September 18 – September 22, 2023

Opportunities In a Shifting Market

Doug Walters, CFA
The ‘higher for longer’ Fed messaging has hit Growth stocks of late, but there may be opportunities amongst this weakness.

Contributed by Doug Walters, David Lemire, Max Berkovich, Eh Ka Paw

Stocks slipped this week as we begin the final approach to the end of the third quarter. Investors had a lot to digest with a Fed announcement, labor unrest, and the resurfacing of the debt ceiling debate. Only one of those is material to investors, in our opinion.

In the US, unemployment is incredibly low, and the battle against inflation is going better than in most regions around the globe. Compare our 3.3% PCE inflation to Argentina at 124%, Turkey at 59%, or Europe more broadly at 5.2%. Yet the news commentary seems decidedly dour. It doesn’t help that the stock market is down over 4% this month (most of which was this week), albeit the S&P 500 is still up over 12% year-to-date.

So, what is driving the slip? The Fed is the most likely culprit. Its decision not to change rates was not surprising. However, the commentary was clear that investors should expect rates to remain higher for longer (see our Headline of the Week below). This is not great news for Growth investors. High-interest rates should hit Growth stock valuations the hardest, and we may be starting to see the market reflect that fact.

Mega-cap Tech companies like Apple, Amazon, Microsoft, Alphabet, META, Tesla, and NVIDIA are down around 10% from their peaks on average. We’ve discussed the hidden risk these mega-cap stocks bring to market-cap-weighted indexes like the S&P 500. But the flip side of that risk brings opportunity.

As evidence-based investors, we worry less (or not at all) about investment timing and more about identifying attractive long-term opportunities. The current market has a few. One of those is Value stocks, which have underperformed Growth dramatically this year. Historically, more often than not, considerable underperformance has been followed by strong outperformance. Will the next 12 months be Value’s turn to shine? Only time will tell. But for long-term investors, it sure looks like an attractive entry point.

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The Fed held rates constant

The hold on rates was no surprise. There was more interest in the accompanying commentary.

Headline of the Week

The Elusive “Neutral Rate” Rattles Markets While The Fed “Proceeds Carefully”

As expected, the Fed did not raise rates this week, leaving one more rate hike for this year on the table. There was hope that the Fed would signal that they were done, but nobody should be surprised that they did not oblige.

As we have written, the how high question remains largely settled (or at least the worst-case scenario – one more hike – seems settled). The answer to the second question, how long will rates stay high or, conversely, how soon until rate cuts start, was not received well. Rate projections hint at only two rate cuts in 2024, down from four forecasted in June.

A rising number of Fed officials see that the “neutral rate” (which enables steady growth with low inflation) has crept higher. Where this rate is currently and how much higher it is headed requires more art than science. In the current environment, the string of rate increases has not been as effective at curtailing demand and bringing inflation back to the Fed’s 2% target. This economic resilience indicates that the neutral rate must be higher, but again, it is not a calculated figure. Fed officials estimate the rate, and the change in these estimates initially rattled markets.

Not unlike long family car trips with shouted questions: “When are we going to get there!?” or “How much longer!?” the Fed Chair responded by repeatedly mentioning the need to “proceed carefully” as a soft landing is a goal, and it remains in reach.

The Week Ahead

The week after a Federal Reserve meeting kicks off the prophesizing of the next meeting’s outcome. There is no better way to start that than Personal Consumption Expenditures (PCE) inflation and spending reports, with some assistance from Consumer Sentiment and Durable Goods Orders reports.

And We’re Off!

PCE inflation report is the Federal Reserve’s favored inflation indicator, so it should not be a surprise it is the most critical driver of next week’s markets unless Congress finds a way to a budget deal.

  • The big question is, since energy costs are moving higher, has progress on inflation hit a hurdle?
  • Current predictions expect a monthly increase of 0.2% in August, which would still bring the annual figure down to 3.8%.
  • However, energy prices aren’t the only thing that can disrupt progress. There are fears that strong consumption may fuel inflation on top of that.
  • Personal spending is expected to keep growing but moderating slightly in August.
  • Personal income is also expected to improve a bit.
  • The odds of another hike increase if any of these numbers exceed expectations.
  • Durable goods orders and the University of Michigan Consumer Sentiment Index will offer a fresh look at the consumer.

Is That Your Final Answer?

The final look at the Gross Domestic Product (GDP) isn’t as important as it should be because of previous revisions and the fact that the next quarter is about to end.

  • The previous revision caught the market off-guard as the change was expected to be higher and ended up being revised down.
  • The last revision was dinged by falling inventories and slowing business spending.
  • The initial report was a 2.5% expansion that was revised to 2.1% upon a second look.
  • Let’s hope the final revision can nudge us closer to the initial number before the book closes in the second quarter 2023.

A Teaching-In

Federal Reserve Chairman Powell will host a town hall with teachers on Thursday.

  • The in-person and virtual participants will be asking the Chairman questions.
  • Hints of what the central bank is watching could be helpful to prophesiers of interest rate moves.

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