Market returns were negative in August, as interest rate increases and concerns about the potential for additional increases in interest rates weighed on markets.
Throughout the summer, the primary driver of market returns has continued to be interest rates. Stock and bond price movements react in the opposite direction of rate movements. Intermediate term interest rates popped up sharply during the first half of August and stock prices dropped as a result. During the second half of August, interest rates came back down a bit and stock prices partially rebounded. Looking forward, it is encouraging that inflation has continued to decline and the Fed is most likely done increasing the short term interest rates they control. On the other hand, it is discouraging that the yield curve is still inverted (longer term rates are lower than shorter term rates) and we expect intermediate term interest rates to continue to slowly climb. This is likely to eat into total returns during the next year, but at a slow pace that should be offset by earnings growth and dividends.
It grabbed headlines and the attention of many investors when the average rate for a 30 year mortgage blew through the 7% level during August. Rising mortgage rates make home ownership more expensive and have a detrimental impact on markets for multiple reasons. First, when rates are higher, any new home owner or existing mortgage holders with adjustable rates must allocate a higher amount of their budget to cover their monthly mortgage payment, reducing the amount they can spend on other goods and services. Second, prohibitively high mortgage rates lead many prospective home buyers to postpone buying, slowing revenues for any company connected to the real estate industry, including; builders, lenders, realtors, materials manufacturers, furniture producers and retailers, etc… Third, higher rates result in lower home values for all home owners, making them feel less wealthy and often dissuading them from spending, slowing the economy in general (what economists call “the wealth effect”).
Whether markets have any steam left for the remainder of the year will depend on whether corporations are able to hit their lofty revenue and margin targets in Q3 and Q4. Many companies have given guidance that they expect results to improve meaningfully, which has led some forecasters to expect aggregate earnings for the S&P 500 to climb back to $220 for each share of the blended index overall by the end of 2023. If these lofty, expected corporate accounting results are achieved, prices should continue the healthy growth we have seen during 2023. If companies miss their targets, we could see easily markets finish the year flat or slightly lower.
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