August 2023 Market Lookback

Economic data such as retail sales, consumer spending, and business inventories pointed to robust growth last month, and inflation data continued to look promising. In a sign of shifting views on the trajectory of the U.S. economy, longer-term Treasury yields rose in August while short-term tenors ended the month down. This mix led to the worst month for stocks since February 2023, as valuation multiples compressed even as earnings estimates remained stable or even grew. Against this backdrop, volatility in both stock and bond markets rose before returning to muted levels by month-end.

Macro

•   The unemployment rate rose to 3.8% in August due to an increase in labor force participation (i.e. available workers), after inching down to 3.5% in July. The labor force participation rate rose to 62.8% in August after remaining flat at 62.6% in July.

•   July CPI came in mostly in-line on both a headline (0.2% m/m, 3.2% y/y) and core (0.2% m/m, 4.7% y/y) basis.

•   Q2 GDP and GDI rose at an annualized rate of 2.1% and 0.5%, respectively, while the Atlanta Fed Q3 GDP Nowcast stands at +5.6%, which would be the highest since Q4 2021.

•   Retail sales grew 0.7% m/m in July, notably above the pre-release estimate of 0.4%.

•   Job openings declined to 9.2m and 8.8m in June and July, respectively, firmly below consensus.

Equities

•   Bottom-up 2023 EPS estimates for the S&P 500 increased to $222 in August from $218 before, the first monthly increase since mid-2022, while top-down strategist estimates were flat at $216.

•   The S&P 500’s total return of -1.6% in August was its worst month since Feb 2023.

•   Large-cap stocks outperformed small-cap stocks by ~3%.

•   International stock indices underperformed U.S. stocks, weighed down by weaker growth and currency volatility relative to the U.S.

•   After spending most of June and July in a range of 13-15, the VIX rose to as much as 17.9 in August and spent much of the month above 15.

Fixed Income

•   Having started the month at 3.96%, the 10-Year Treasury yield rose to as much as 4.36% before ending August at 4.11%.

•   Real (i.e. inflation-adjusted) Treasury yields rose to their highest levels since 2008-09.

•   HY bonds outperformed Treasurys and IG bonds for the fifth month in a row, the longest such streak in over two years.

Crypto

•   Bitcoin and Ethereum had their worst months since November 2022.

•   A federal court ruled against the SEC’s decision to block Grayscale’s Bitcoin ETF application.

Sorry Ms. Jackson

Toward the end of the summer months, central bankers, academics, economists, and others from across the globe gather in scenic Jackson Hole, Wyoming, for a symposium on economic policy. Each year sees discussion centered around a different topic, with the Federal Reserve Chair typically kicking off the day.

This year’s symposium topic, Structural Shifts in the Global Economy, led some to speculate that Jerome Powell might drop a bombshell. More specifically, some thought that Powell might indicate that the interest rate that stabilizes inflation in an economy at full employment — also known as R-star or the neutral rate — is higher than previously thought. For example, the implied real yield on 5-year Treasurys five years in the future moved up throughout the month.

Such a move in these inflation-adjusted yields implies structurally higher rates, so surely Powell ended up validating market pricing… right? Wrong. Powell did not say the neutral rate moved up. Instead, he emphasized just how much uncertainty there was: uncertainty in the economic outlook, uncertainty about the neutral rate, uncertainty about the precise level of monetary policy restraint. As Powell put it, the Fed is “navigating by the stars under cloudy skies”, keeping their options open and waiting for more data before deciding what to do next.

The Fed is for Real

This year’s speech may have seemed somewhat benign compared to last year’s hawkish speech, but it’s important to not miss the forest for the trees. The Fed believes getting inflation back down to 2% will require below-trend growth and more labor softening. While growth has remained hot in 2023, Powell noted that there may be significant further drag in the pipeline. In other words, just because growth has not yet slowed down doesn’t mean it won’t. It might just take a while, which is why the Fed has emphasized holding rates at an elevated level for a period of time.

Strong growth and positive real interest rates also generally support a country’s currency, especially when other countries are facing weaker growth (e.g. China and the EU). See the U.S. dollar’s sharp appreciation over the past month or so. A stronger dollar generally makes foreign goods cheaper, while making domestic goods more expensive abroad. That could help the Fed’s cause by softening demand, and in turn, reducing inflationary pressures.

In many ways, the Fed’s fight against inflation is entering a new phase where they must be careful not to overdo it and cause unnecessary economic pain. Whatever comes next, we know that the Fed, as Powell closed his speech out and has repeated often over the last year, “will keep at it until the job is done.”

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