CWG Investment Committee: Are We in for a Fall This Fall?

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While much of the country experienced blazing temperatures in August, the U.S. stock market cooled as the S&P 500 and Nasdaq both had their first negative month since February. The S&P 500, Nasdaq, and Dow Jones returned -1.8%, -2.2%, and -2.4%, respectively, during the month.

The bond market was the main source of angst for equities. The 10-year note hit its highest daily close since 2007 at 4.34% in August, before finishing the month at 4.09%.

Despite the pullback, YTD gains through the end of August remain strong, with the S&P 500 up 17.4%, Nasdaq up 34.1%, and Dow trailing at 4.8%. The Russell 1000 Growth index has rallied 33% YTD almost making up for last year's losses.

We are now just 6.6% below the S&P 500 all-time high of 4,818 set in January 2021.

Unemployment rose to 3.8% in July, well below the 5% full employment level the Fed of yester-year tried to attain. The July CPI came in at 0.2%, rising 3.2% over the last 12 months.

The Q2 earnings season has concluded, and S&P 500 companies delivered better-than-expected results as 80% reported above analysts’ average expectations. However, this marked the third straight quarter of Y/Y declines for earnings.

According to FactSet, analysts have just increased S&P 500 companies EPS for the third quarter by 0.4% to $56.10. 

This is the first bottom-up EPS increase since Q3 2021. Consumer Discretionary stocks were up 6.3%, Communication Services +5.3%, and IT at +3.8%. Seven of the 11 S&P sectors had decreased estimates for Q3 led by Materials -12.4%. Earnings for Utilities, Energy, Materials, and Healthcare are now negative for the calander 2023.

Ed Yardini, an old hand on Wall Street, forecasts S&P 500 EPS as follows:

2023 = $221.01

2024 = $247.09

2025 = $278.10

At the current market levels, we sit at 18.3x Yardini's forward 2024 estimate. We can also derive an earnings yield of 5.5% from his estimates, nearly equal to the 5.4% yield on risk-free 1-year Treasury bills. The current yield of 4.1% on U.S. Treasury 10-year notes is by comparison not very attractive given recent inflation rates.

Six-month Treasury bills have exceeded 5.5% and the two-year Treasury note climbed over 5% in the last auction. Given these current risk-free rates, we can better balance portfolios and not forfeit returns from our fixed income components.

The sentiment of individual investors, according to AAII, reached a high for Bulls on July 18th with a reading of 51.4% which helped the S&P 500 to get through 4,600. The high for the Bears was 60.9% in September 2022, just before the early October 2022 bottom which now appears to be the Bear market low for this cycle.

We now sit at 33.1% Bulls, 32.4% Neutral, 34.5% Bears. The Bulls anticipate lower inflation, an end to Fed hikes, plus better earnings ahead after a shallow economic slow. The Bears fear a deeper recession than forecast, a return to higher inflation, and confrontation with China or Russia.

Overall, the economy has continued to defy expectations of a recession due to resilient consumer spending and a tight labor market. Investors have benefited. However, core inflation remains too high and the full impact on business investment from the Fed’s tightening may not have been realized yet.

September is often a down month for the averages, but the future continues to offer better prospects for patient investors.

Hopefully the market can continue to stay hot in 2023 while we all enjoy some cooler temperatures this fall.