Occasional Daily Thoughts June 30th

By LaRue Gibson on June 30, 2023

Three questions animate most discussions about the markets today:

• Will the U.S. economy transition to recession?
• When will the Federal Reserve stop raising interest rates?
• Will the stock market continue to surprise to the upside?

The following graphics will provide our readers with our thoughts and insight. Data inform market prognostications, so we may adjust our conclusions as new data arrive.

The bond markets clearly project a recession for the U.S. economy. As the below illustration demonstrates, the Federal Reserve’s benchmark interest rate exceeds the yield on 30-Year Treasury Bonds by greater than +1.4% and has done so for several months. Historically recessions ensue.

Additionally, we note that the Conference Board’s Index of Leading Economic Indicators (LEI) strongly correlates with expansions and contractions in economic activity. We spy a deterioration in the Board’s LEI lately.

Yet, the relative performance of consumer discretionary shares to consumer staples shares communicates a risk on posture in the equity markets. Who is correct?

Considering the data to this point, expecting the Federal Reserve to ease its tightening regime does not appear until the unemployment rate rises or the rate of inflation evanesces or both. 40 years of historical data implies that the Fed will want to see the unemployment rate higher than the rate of inflation as measured by the Consumer Price Index before it cuts rates. We shall see.

Furthermore, we believe the Fed will wish to see short term inflation expectations to anchor more closely to its 2% inflation rate target. As the following graphic illustrates, inflation expectations have improved, but more is required.

Finally, the S&P 500 Index has fulfilled our post mid-term election predictions thus far. Regular readers remember that after a difficult mid-term election year for equity markets, history suggests a robust rebound from the cycle low. As of this writing, the S&P 500 Index has recovered over 27% from the October 12, 2022 low.

The recovery has been narrow with only seven to ten mega-cap stocks accounting for nearly all the market performance.  Nonetheless, the following data suggests that complacency may have developed. The Nasdaq trades 20% above the average price of the past two hundred trading days. Historically, markets pause when this occurs.

The VIX measures volatility and, so, provides a window into the amount of fear market participants feel. The readings indicate a great deal of complacency in investors. Our contrarian senses tingle. We remind you of the calendar and seasonal factors too. The August to October timeframe has provided choppy to poor returns in the past. Our adage: By the end of July, have your powder dry.

As the dog days of summer descend, LRG Wealth Advisors wishes you a peaceful and restful respite from life’s challenges. Please feel free to contact us with any questions, thoughts, or concerns. Take good care!