A Textbook Seasonal Correction: Rates Rise as Summer Winds Down

A Textbook Seasonal Correction: Rates Rise as Summer Winds Down

August 23, 2023

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A week and a half ago I wrote a special report on debt. The reason was twofold. First, the amount of debt on the balance sheet of the U.S. Government is worrisome and continues to lurk in my mind as an ominous elephant that refuses to leave the room! The second reason is that interest rates continue to rise, and this tends to suck all the oxygen out of the room for stocks, making it increasingly difficult for stocks to rise when short-term CDs and Treasuries are sucking up the capital that is sitting free on the sidelines. There is a measure called the “equity risk premium” that measures when valuations on the broad market of stocks are measured against the current rate of interest on Treasuries. This is where it stands currently:

This rate rise can really only happen for so long as, eventually, it will stop the growth of business and the level of inflation will subside if rates are raised too much. The predicament is that CPI and PPI are rolling over, yet wages and consumption measures are not. Fed Chair Powell says that his focus is on employment and, by association, wage rates, so he is sort of stuck watching measures of pricing at the consumer level and producer levels start to roll over, but employment is being stubbornly sticky, with wages are rising at a slow but sustainable pace. The key will be if the Fed sticks with their 2% target inflation rate, or if they take a look back in time and set it to a more realistic 3% level. This might be addressed in Powell’s speech in Jackson Hole this week. To give color on this point please see the picture below of the PCE Indicator of inflation, and where we are based on history.

The 10-year U.S. Treasury yield is breaking out above a level not seen since 2007. In just the last week it has eclipsed the highs it initially put in back in October 2022—not good! So, we are faced with this dilemma: "Can strong earnings for stocks offset higher interest rates?" In my experience with equity markets, the answer to that question is NO.....even strong earnings cannot offset a sharp rise in interest rates. In this last week's Barron's there was an article titled, "Higher Rates Ahead." Adding fuel to this fire are the prices of food and gasoline. Both of which are experiencing higher price levels even in the face of negative imports. U.S. real imports fell 4.8% year-over-year in 2Q23. Since 1970, real imports have never been this negative outside of a recession or its aftermath. In China, its latest data shows that imports were down 12.4% year-over-year, while exports were down 14.5%. Clearly, China is in an economic tailspin, and this is being mirrored in Europe as the war in Ukraine drags on, destroying the balance of trade in continental Europe. I mentioned this last week in referencing Germany, the core of the growth engine of Europe.

The stock market received a reprieve from the selling Monday – sort of. The mega-cap tech stocks that dominate the S&P 500 and NASDAQ 100 got a lift, yet under the surface the buying wasn't nearly as strong. The Dow Jones Industrial Average finished down on the day, as did the small-cap Russell 2000.  It certainly wasn’t the kind of 80-90% upside day that often signals that buyers have returned in masse to carve out a bottom. So, I still think more work needs to be done before we can have more confidence in a tradeable low being struck. We witnessed a similar two-session jump back on August 11-14 when it looked like some sort of low had been made in the S&P 500. But breadth then, too, didn't support the bounce and it quickly faded and rolled back over.  My main point in bringing up this Monday's action is to clarify that despite the day's "rally," I have not seen enough to proceed as if any sort of bottom is “in.” The rest of this week will be an important next few sessions for the market.

The largest big-cap semiconductor company reports earnings today after the close and its response may dictate where the market heads next in the very short run. And then, of course, we have the Fed's Jackson Hole symposium and Jerome Powell scheduled to speak on Thursday & Friday. These events are expected to be market-moving. To quote statistics, the markets tend to be positive the week after Jackson Hole. If Powell is not too strong on interest rates, the 10-year yield could back off and the equity markets may stop their August malaise. This is what we have experienced for that last two months:


The S&P 500 is down 5% since the start of the month, and over the past week or two, new concerns have emerged in the market. They are all sort of piling on and what I find sort of interesting is that this piling on has not caused a fearful waterfall sort of decline. The vast majority of institutions cite the rise in interest rates which I mentioned above. I mentioned it as it makes the most sense as short-term guaranteed instruments are a riskless way to wait for more information before one decides to commit dear capital in a difficult environment- particularly one that has been very strong for the first 7 months of the year. So, what happened when interest rates were up at the current level of 4.3% back in February? Well, things started to break! That is when we had the financial crisis in the regional banks and Silicon Valley Bank collapsed, soon to be followed by the "take under" of First Republic. This was when the Fed did its "dovish" pivot and rates settled back down. 

Many put targets on where the broad S&P 500 should come down to before this corrective move is over. Many feel that this August sell-off bottom will coincide with Powell's comments at Jackson Hole. I think it could provide a level of respite, but unless interest rates back off this market digestion could continue into September. I keep a very close eye on the U.S. Dollar, and you have read me mentioning this many times before. The U.S. Dollar continues to rise against other currencies but with massive debt in place and this number continuing to increase year-over-year, the greenback’s strength could be on borrowed time. Yet, currently, the dollar is strong against competing currencies. As I mentioned above, with China's economic issues, and recessionary economic trends in the EU, we remain the strongest currency. 

The positive earnings reports of a few leading technology companies may add to the indexes as was the case at the beginning of this week, but will this be enough to turn the tide on this pullback in the broad indexes moving forward? Time will tell, but at present, as I have been saying for the last few weeks, August tends to be weak, particularly in a pre-election year and even more so (statistically) when it has been up over 10% for the year coming into August. I believe sticking with quality, and letting the sell-off exhaust itself is the best policy for fresh capital. But don't wait too long as this market seems to have quite the mind of its own, even in the face of rising interest rates and the feared recession still looming on the horizon. I don't expect to write anything on Friday about what Powell has to say, but the action this week into the end of August should be quite interesting. I will close with an update on where we are compared to the past 10 election periods:

Please let us know if you have any questions or concerns. We are always here to help in any way we can.

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