November 2023 Market Commentary
November 16, 2023
- Markets endured another disappointing month impacted by a further rise in rates. The S&P 500 briefly entered “correction” territory just before month end.
- Higher rates resulted from a combination of factors.
- Third quarter economic activity surprised to upside, but there are growing reasons to be concerned about the consumer moving forward.
- Returns: S&P 500 down 2.2%. Bloomberg US Aggregate Bond index down 2.5%.
Markets remained under pressure in October as longer-term interest rates continued to climb, putting further pressure on equity and fixed income markets. After reaching a year-to-date high at the end of July, the S&P 500 briefly entered correction territory (a pullback of 10% or more from recent highs) at the end of October. Despite the market declines, economic activity remained surprisingly resilient, continuing to buck the near unanimous consensus at the start of the year that the economy would be in recession by now. The juxtaposition between the month’s disappointing market performance and relatively upbeat economic data served as a good reminder that Wall Street and Main Street are not one in the same.
The continued ascent of longer-term rates and further normalization of the yield curve, known as a “bear steepener” in fixed income parlance, weighed on equity markets returns. For the month, large caps (S&P 500) declined 2.2%. Small caps (Russell 2000), which tend to be more interest-rate sensitive, declined 6.7%, their worst month since September 2022. Higher interest rates make it harder for smaller companies to borrow money to either fund new projects or refinance existing debt. By comparison, larger companies tend to have stronger balance sheets and generate greater cash flows thereby making them more financially resilient than smaller companies. International markets also experienced declines, with developed (MSCE EAFE) and emerging (MSCI EM) markets falling 4.1% and 4.0%, respectively. The pullback in equity markets stood in contrast to economic data which remained quite strong.
Third quarter GDP data released in October surprised to the upside as the economy expanded 4.9%, its fastest pace since 4Q21. That easily exceeded the consensus estimate of 4.3% and more than doubled the 2.1% pace recorded in 2Q23. Growth was broad based with all four components- consumer spending, business spending, government spending, and trade- contributing. Consumer spending was particularly robust at 4.0%, its fastest pace since 4Q21.
Given the importance of the consumer to overall economic activity, the strong growth recorded in 3Q23 was encouraging. However, it is fair to question how much longer that can be sustained. During a large part of the post-pandemic recovery, consumers have experienced negative real wage growth, resulting from inflation exceeding nominal wage growth. In the immediate aftermath of the pandemic, workers briefly enjoyed a period of positive wage growth. However, by April 2021, with inflation surging, wage growth turned negative, and remained so for the next 25 consecutive months, until May 2023. During that time, to offset the effects of lower real wages, consumers did two things; 1) drew down on savings, and 2) turned to credit cards.
In February 2020, just prior to the pandemic, the personal savings rate stood at 7.7%. In April 2021, following the pandemic, it stood at 12.3%, aided by Covid-stimulus, and Covid restrictions which curtailed spending. By May 2023, however, the saving rate had fallen to 5.3%. In addition to drawing down on savings, consumers turned to credit cards to sustain spending. At the end of 2019, just prior to the pandemic, total credit card debt stood at $930B, according to the Federal Reserve Bank of New York. By the end of 1Q21, it had declined to $770B as consumers cut back on spending during the height of Covid and used Covid-relief funds to pay down debt. However, from 2Q21 to 2Q23, credit card debt reaccelerated, growing 40% to $1.08T. Making matters worse, the increase came as the average credit card rate jumped to new record highs, estimated at 24-27%, depending upon the source. At the start of the pandemic the average credit card rate was in the mid-teens.
Adding further pressure to the consumer, student loan payments resumed in October, after being suspended since March 2020. Collectively, ~44M borrowers owe ~$1.6T in student loans. While it’s reasonable to assume consumers could maintain their spending habits for some period in the face of tighter financial conditions, it would be naïve to believe they can maintain those spending levels indefinitely. Unfortunately for the consumer, the Fed has talked repeatedly about the lagged, cumulative effect of its rate hikes, and the need to keep rates “higher for longer” moving forward. In other words, pressure on the consumer may get worse before it gets better. Given that the consumer accounts for ~70% of US economic activity, should the consumer be forced to curtail spending, slower economic growth will ensue.
Bond market volatility, which slowed through much of September, surged in October. As a result, the Bloomberg US Aggregate Bond index, the broadest measure of the US bond market, declined 2.5%. That marked the 6th consecutive monthly loss, the longest streak on record dating back to 1976. The initial catalyst for higher rates was Congress narrowly avoiding a government shutdown. Prior to the spending deal, Treasury yields had fallen as the shutdown deadline loomed and investors sought the safety of Treasuries. Following the deal, investors sold Treasuries, reflecting a “risk-on” sentiment. The selling drove yields higher and was further fueled by an unexpected jump in job openings. Prior to that, the Fed had been encouraged by recent declines in job openings, theorizing that the reduction was indicative of a labor market decline that would help ease inflationary pressures. The sudden reversal in openings led markets to begin factoring in the potential for additional Fed rate hikes, further boosting yields. Soon thereafter, Hamas attacked Israel. In the immediate aftermath, the threat of a wider regional conflict drove investors back to the safety of Treasuries, pulling yields down to their monthly lows.
Treasury auctions were another factor behind the elevated volatility. Often overlooked by investors, of late the auction results have had an outsized influence on markets as concerns about growing US deficits, and whether there will be sufficient demand to fund them, increase. A weak 30-year auction mid-month raised concerns that reduced demand for US debt will result in higher long-term rates. The spike in rates from the weak auction was amplified by a blowout retail sales report, showing the US consumer remains very active despite the higher interest rate environment. The strength of the report put the possibility of further hikes by the Fed back in play. As a result, the 2-year Treasury yield moved to a new 17-year high and the 10-year Treasury yield to a new 16-year high. The rise in yields to multi-decade highs and the ongoing threat of war aggressively drew investors back into the market, driving yields back down in the final days before month end. The rally, particularly on the short end of the curve, was helped by comments from Fed members indicating that they don’t anticipate any immediate hikes; content instead to observe the lagged effect of their aggressive hiking cycle and its potential to bring inflation down to targeted levels. Despite the volatile month, 2-year Treasury yields finished up just 5 basis points, while the 10-year yield saw a larger 36 basis point jump, further complying with the Fed’s “higher-for-longer” rate expectations. Municipal bond yields, following the direction of Treasuries with a slight lag, closed the month just below 14- to 16-year highs across the curve.
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