As we head into the final stretch of 2023, here is a review of the third quarter’s key market and economic developments.
S&P 500: A Breather After Three Straight Positive Quarters
Overall, stock market bulls were on the retreat during the third quarter of 2023 as several major stock indexes traded lower in response to rising interest rates and a strong dollar.
In fact, after three consecutive positive quarters for the S&P 500, the large-cap index found some sellers in the third quarter. Utilities and real estate contributed to the selling, while the energy sector surged.
Tallying the numbers, the S&P 500 decreased by 3.65%, the Nasdaq 100 fell by 3.06%, and the Dow Jones Industrial Average fell by 2.62%.
Economy: Soft or Hard Landing?
Rising interest rates and stubborn inflation remain front and center. The Federal Reserve has clearly communicated its “higher for longer” expectations on interest rates, and the message is starting to sink into the markets.
A recession induced by a rate-hiking Fed and pesky inflation is still a distinct possibility. Interest rates rose steadily across various durations and products throughout the quarter, and a tighter lending environment is a factor in the financial markets.
Inflation Mixed for Quarter, Ticks Higher
Inflation metrics were mixed in the third quarter, with consumer inflation reversing its previous downward trend and picking up in August and September data releases.
The last Consumer Price Index (CPI) release of the quarter showed a 3.7% rise year-over-year in August versus 3.6 % expected. This was much higher than the 3.2% rise year-over-year in July. The recent uptick in headline consumer inflation helps to support the higher-for-longer interest rate narrative that the Fed is broadcasting.
Core CPI (which removes volatile food and energy) ran a little hot in August but remains in its downtrend for 2023, providing a mixed theme on inflation. With that said, we don’t need to be economists to realize that food and energy are the things that are hurting our pockets.
Labor Market: Goldilocks?
Labor market resilience persisted throughout the third quarter, with solid payroll gains (187,000 in August, 187,000 in July, and 209,000 in June). Two out of those three numbers missed analyst consensus expectations, but not by much.
Some analysts call it the perfect labor market for the Fed, even goldilocks-like, as a gradual cooling is noted, yet with continued strength. A continuation of this pattern in employment data could help to cool the Fed's rate-hiking desires. The unemployment rate also showed a mixed picture for the third quarter, but there was a notable spike in unemployment in the last monthly data release of the quarter.
Fed Summary & Outlook
The third quarter featured two Federal Reserve meetings, with the Fed raising rates by 25 basis points in July and leaving rates unchanged at the September meeting. The result is a current target overnight lending rate of 5.25 - 5.50%, a 22-year high.
While the Fed left rates unchanged at the most recent meeting, it did let us know that policy could remain “restrictive”. The Fed also indicated it would need to see more evidence that inflation is under control for these restrictive levels to be changed.
At the end of the third quarter, markets were pricing an 81.7% probability of no rate hike at the November meeting (18.3% chance of a 25-basis-point hike) and a 64.8% probability of no hike in December (31.4% chance of a 25-basis-point hike), per the CME FedWatch Tool.
The consensus at the start of the fourth quarter is that there will be one more hike in 2023. The Fed is heavily data-dependent, so probabilities may shift over this quarter in relation to key data releases.
How High Will Rates Go?
That is the million-dollar question (or billion-dollar, adjusted for inflation)! Jamie Dimon, CEO of JPMorgan, notably said, “I am not sure if the world is prepared for 7%,” when referring to the Federal Funds Rate.
But, ultimately, opinions differ. Let us remember that the interest rate-corresponding 10-year note yield sat near 4.57% at the close of the third quarter, but it traded above 5.06%from 1967 to 1998! Yes, it spent 31 years above that threshold, and it actually reached highs north of 15% in 1981.
So, while many want to be the Nostradamuses in the room and say that the Fed is done hiking or rates have peaked, there is always the other side of the coin to consider.
Looking Ahead
It was an eventful quarter in the financial markets, and it is still a highly Fed-centric market, with any clues presented by labor and inflation data being front-and-center.
Investors may have to get used to higher rates, potentially even higher than present levels based on historical patterns. The good news is that the fourth quarter is historically the best quarter for stocks. Time will tell if that pattern holds true this year.
Please feel free to reply to this email or call me.