The financial markets have experienced increased volatility in the last quarter, with equities still up this year but down from their recent highs. This has been in large part driven by interest rates which reaccelerated their upward trend in recent months after declining in the first half of the year. A resilient economy and strong labor market have largely driven the rate increase, with the Federal Reserve signaling an intent to keep rates “higher for longer” to reign-in inflation. Several factors continue to reinforce an uncertain outlook, however. The Friday, October 6th job report provided mixed results, with job growth accelerating at a surprising pace (336,000 jobs versus an expected 170,000) but wage growth slowing to 2.5%, just above the Fed’s inflation target. Additionally, the weekend news of an emerging Middle East conflict may cause oil prices to rise, which could erase some of the Fed’s progress in slaying the inflation dragon. In sum, markets are digesting new information and the impact that higher rates could have on stock multiples and earnings growth. New information can mean new short-term volatility. We will be paying close attention to the September CPI and PPI reports, which are released this week.
This is not the first time the market has been concerned about interest rates and recession risk, as this narrative has taken hold on several occasions in the last year. Each time, inflation trends subsequently improved, with the economy and labor markets surprising to the upside. These “head-fakes” provided much of the foundation for the mid-year rally, but with rates now at their highest level since 2007, the market is asking if it’s finally different this time. Recent datapoints do suggest a slowdown is occurring, but inflation remains at 4%, above the Fed’s 2% target.
This year has been an anomaly in the markets. Gains this year are highly uneven, with just ten stocks accounting for almost all of the return in the S&P 500 return this year. These companies, by and large, are in the technology and semiconductor sectors, where new Artificial Intelligence capabilities have caused a surge of enthusiasm and earnings growth. However, the other 490 stocks in the S&P 500 are flat-to-down, signaling just how challenging of a year it has been for American corporations. Fortunately, Greenwood Gearhart’s strategic exposure to technology has provided protection during this time of variability.
We have been monitoring this dynamic and have begun to make tactical changes in the portfolio to better insulate against dispersion in returns, while benefitting from stocks that may rally at the bottom of the indices. Whether or not a rally manifests in the fourth quarter will largely depend on whether earnings begin to deteriorate from a slowdown of demand and higher cost of capital. Thus far, they have held up, but we’re starting to see challenges in sectors highly dependent on interest rates, such as utilities, real estate, and banks. Bottom line, we are acting with your long-term goals in mind.
We will continue to monitor these changing factors and remain vigilant for opportunities to add value to portfolios.