“Life isn’t about waiting for the storm to pass…It’s about learning to dance in the rain.”
― Vivian Greene
So why all the buzz about Jackson Hole?
Market participants are watching Jackson Hole for any sign of sentiment from central bankers as to the outlook for interest rate policy. After the July Fed meeting and the quarter point increase of the federal funds rate to a range of 5.25% – 5.50% the consensus of the market became that the Fed was done hiking and celebration ensued. “Sure, they may hold rates at this level for a while, but inflation is clearly on a downward trajectory, and they’ll have to cut rates eventually” the thinking went. The long road of rate hikes was finally done, and risk assets were back! However, sentiment seems to have moderated a bit recently. The release of Fed minutes from the July meeting showed that many policymakers are still concerned about persistent inflation and are at least open to the idea of further rate increases, although some divisions have begun to emerge.1 When measuring inflation, economists are always working with data from the previous month, so the information used in the July meeting was a snapshot of prices in June. As an example to which most people can personally relate, gas prices have climbed steadily since the end of June which puts upward pressure on headline CPI (the US Consumer Price Index). Indeed, US CPI year-over-year rose from 2.97% in June to 3.18% in July driven mostly by food and energy prices.2 Although this is a modest increase in only one measure of inflation, it is not an unbroken downward trend that would support near-term rate cuts. As seen on the CME FedWatch Tool (see chart below) the market is still confident that we aren’t due for a rate increase in September, giving a quarter point hike only a 15.5% probability. That said, market participants would surely like to know just how long rates will remain at a “restrictive level”, whether the Fed is open to inflation being moderately above 2%, and just how much unemployment they are willing to tolerate to reach the inflation target. That is why there is so much talk about Jackson Hole this week.
Market Expectations for Future Federal Reserve Interest Rate Decisions
Source: https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html
What’s Going on in China?
Outside of the United States, China, the world’s second largest economy, has faced difficulties which have caused some concerns for markets. Global markets are not siloed, so effects in international markets can impact sentiment in domestic markets. The topic of China’s economy is one that requires significant backstory and several publications have already done this quite well, so I won’t attempt to deep dive this topic. If you would like to read more on the topic this blog is a nice succinct explainer, or you can read a lengthy article from the Wall Street Journal. However, there are some recent headlines worth noting. In short, China’s economy is heavily focused on real estate investment and development, and some cracks in the industry have recently appeared. You may remember headlines about Evergrande Group, a major Chinese property developer, running into financial troubles back in 2021. Last week, Evergrande Group filed for bankruptcy protection in the U.S.3 News also broke last week about Zhongrong International Trust Co, a Chinese asset manager, missing payments on investment products.4 The third major headline is about Country Garden, which was the largest Chinese property developer last year, and which has missed payments this month on some of its debt securities. Technically Country Garden is currently in a 30-day grace period to meet these obligations, but the missed payments sparked fears of potential bankruptcy.5 Again, the problems these companies are facing do not directly impact domestic stocks, but market fears in such a large economy can have a depressing effect on sentiment in other markets.
Credit Ratings of U.S. Banks
On Monday, the credit rating agency Standard & Poor’s downgraded the credit ratings of five regional U.S. banks: Associated Banc Corp, Comerica, KeyCorp, Valley National Bancorp, and UMB Financial.6 Earlier this month another rating agency, Moody’s, also downgraded the credit rating of some U.S. banks.7 These credit rating downgrades were largely due to the pressure of higher rates on banks’ balance sheets and the level of exposure these banks have to commercial real estate. While these banks are not a part of Howe & Rusling portfolios, just as with sentiment in China spilling over into sentiment in other markets, the downgrade of these banks dragged down both the regional banks and diversified banks sectors of the U.S. market this month and early this week. For background on the banking turmoil earlier this year, see our March article The State of Banking.
Nvidia and the Wednesday Rally
Finally, you may be wondering why markets rallied so strongly on Wednesday after three weeks of declines and a soft opening to the week. The incomplete, but simple answer is Nvidia (Nasdaq: NVDA). Nvidia released its earnings report after market close on Wednesday, August 23 and optimism about earnings drove a market rally. Outperformance by Nvidia would signal that demand for AI is still a driver of growth in the economy and other mega-cap technology companies which would benefit from an AI tailwind rallied alongside Nvidia, think Microsoft, Apple, and Google. Indeed, Nvidia did beat both earnings and revenue estimates and the price of NVDA jumped again in after-hours trading.8 However, by midday Thursday, NVDA was one of few green chutes in the S&P 500 basket of stocks and by the end of the day it was back near the opening price while the S&P 500 index overall closed down 1.35%. As of the time of writing the price-to-earnings (P/E) ratio of NVDA was approximately 245x which means investors buying today are paying a high multiple for anticipated future earnings. The bar that Nvidia must clear to justify the current price continues to rise.
To sum it all up
The pullback in stocks and lift in bond yields seem to be a recalibration of market expectations. After the Federal Reserve Open Market Committee meeting in July, the markets got a bit overly exuberant about the end of rate hikes and hopes of a soft landing and valuations climbed. With a bit more time and information, along with a realization that high rates may be with us for a while yet, the market has repriced to reflect current expectations. The troubles faced by property developers in China and the downgrade of certain U.S. banks may also help explain some of the market weakness we have seen so far in August. However, the rally on expectations from Nvidia earnings and other AI-related tech companies shows that there is still some optimism in the markets. While it is useful to examine what is driving the markets at any given time, long-term investors would do well to remain focused on their own personal goals and stay focused on their strategies. Like rafting down a river, there will be areas of calm, occasional rapids, and sights to see along the way, but the ultimate destination lies ahead, and the best bet is to remain in the raft. Headlines will come and go, and the markets will react daily, but that doesn’t mean investors must do the same.
Disclosures
This newsletter may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor. Investment strategies, philosophies, and allocation are subject to change without prior notice. This newsletter is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice. Any information provided by Adviser regarding historical market performance is for illustrative and education purposes only. Clients or prospective clients should not assume that their performance will equal or exceed historical market results and/or averages. Past performance is no guarantee of future results. While H&R believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information. Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal. The reader should not assume that investments in the securities identified and discussed were or will be profitable. Any securities identified were selected for illustrative purposes.
2 https://www.bls.gov/cpi/data.htm
5 https://www.reuters.com/markets/asia/country-garden-how-bad-is-chinas-property-crisis-2023-08-17/
8 https://finance.yahoo.com/news/nvidia-nvda-soars-7-q2-122500993.html
