Gill Capital Partners September 2023 Update
The first day of fall arrives this weekend with the autumnal equinox on Saturday. Cooler temperatures, changing leaves, and football mark the changing season. The next couple of weeks are some of the most spectacular in Colorado with mild temperatures, blue skies outlining snowcapped peaks, and the rich colors of the changing leaves. However, this time of year can pose challenges for markets, with seasonal weakness often emerging. In fact, September has historically been the worst month for the stock market, so much so that it has been dubbed the “September Effect.” September has historically been followed by year-end strength as traders buy on weakness, leading to a year-end rally for stocks. These patterns, while statistically significant, do not look exactly the same each year, but have been reasonably consistent over many years. This year we are once again seeing September weakness, though it is too early to see how the rest of the year will play out. There are numerous headlines to discuss, including updates on inflation and much anticipated news out of the Federal Reserve this week.
Inflation Update
We received a monthly update last week on the Consumer Price Index (CPI), which measures inflation. The report for August showed an increase of 3.7% from one year ago, and an increase of 0.6% from a month earlier. Core CPI, which strips out food and energy prices, rose 4.3% from a year ago and 0.3% on a monthly basis.
These numbers were very much in line with estimates. A spike in energy prices drove much of the gain last month, an increase that included a 10.6% surge in gasoline prices. This represents the largest monthly increase this year, but, as stated above, it was largely anticipated. Housing inflation remains sticky and now accounts for nearly two thirds of the entire calculation.
Our view – While inflation increased slightly last month on a year-over-year basis, we are still talking about annualized inflation in the 3-4% range, not the 7%, 8% or 9% range like we were a year ago. Inflation continues to moderate, and while the Fed wants to see inflation closer to 2%, we are now just below the 50-year averages on inflation. While we continue to anticipate a moderating inflation picture, energy prices are moving higher, which means that a source of deflation throughout the past year is now a source of inflation again. Oil prices have moved from below $70/barrel to over $90/barrel recently. Prices at the pump generally hit consumers immediately and there has always been a very high correlation between gas prices and demand. That said, we have noticed an interesting divergence in this time-tested relationship over the past few months (shown below). Gasoline prices (blue line) and spending on gasoline (white line) are moving in opposite directions. This could be an anomaly, or possibly the effects of the rapid adoption of electric vehicles and greater conservation efforts. Either way, perhaps rising gas prices are not as impactful to the consumer as they used to be.
Update on Interest Rates & The Federal Reserve
The Federal Open Market Committee (FOMC) met this week and officials voted to hold interest rates steady at current levels. They suggested that one more hike may be implemented later this year. Fed officials also indicated they expect to keep rates higher for longer than they had anticipated earlier this year. The meeting is being summarized as a “hawkish pause” given both the possibility for further hikes and the Fed’s “higher for longer” stance. Economic activity has continued to be stronger than anticipated, and the Fed is leaving the door open for further rate hikes. While markets fully anticipated a pause, the immediate reaction to the news was not favorable, with equity markets moving modestly lower and interest rates pushing to fresh annual highs.
Our view – Rates are at 22-year highs, having moved dramatically higher from zero in 2021. The Fed may increase interest rates one more time, though our guess is that they are likely done. Perhaps more important than how high rates go, however, are how long these higher rates are here and how low the Fed goes once they begin easing. As you can see in the chart below, the bond market is now in near perfect lockstep with Fed forecasts on forward interest rates. Both the bond market and the Fed believe they are done raising rates and will move lower over the next couple of years. The Federal Reserve has said that they would like to keep rates here for an extended period of time or until imbalances in the economy have been removed. We understand their desire to keep rates high, but we are skeptical simply because it has never happened before.
The chart above shows the previous 3 tightening cycles. The longest that the Fed Funds rate has remained at the terminal rate in any tightening cycle going back to 1970 was 15 months, which occurred between 2005 and 2007, right before the great financial crisis. That was twice as long as any other period. The average time between the last rate hike and the first rate cut is 6 months. Why? When the Federal Reserve raises rates, they tend to break things in the economy and are forced to quickly pivot to rate cuts. This time could be different, but history would say otherwise. We are watching all developments here extremely closely and will continue to keep you updated.
Market Update
Stocks have struggled over the past month but remain up for the year, with a small handful of tech stocks (Apple, Microsoft, Google, NVDA, etc.) having outsized performance. Stocks did not like the rhetoric coming out of the Federal Reserve and the higher interest rates that followed. High growth stocks, which have led the charge this year, have been particularly volatile. As we mentioned in our opening sentences, seasonal patterns appear to be emerging, with stocks showing weakness in September.
Our View – If there is one thing that we have been surprised by this year, it has been the strong performance of equities against the backdrop of an aggressively tightening Federal Reserve and dramatically higher interest rates. We are not surprised to see equities take a break here. Interest rates at these levels for an extended period of time will most certainly take a toll on the economy. Barring a commodity-induced inflation resurgence, we believe falling inflation will provide the cover the Fed needs to soften their tone and begin lowering rates in 2024, bringing relief to banks and commercial real estate markets. Stocks love lower interest rates. When the Fed starts easing rates, it will be a positive tailwind for markets.
As always, please let us know if you have any questions or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.