4Q23 Market Outlook

The Bull Market Case

John P. Swift, CFA, CPA Chief Investment Officer
312-259-9595 or jswift@trustbenchmark.com

Summary

• Rising interest rates and coinciding sell-off in the US treasury market have negatively impacted the equity markets since August 28th.
• Rising oil prices have also contributed to the stock market’s decline over this period.
• Despite the correction, earnings expectations for the S&P 500 remain high, which could support the market in the future.
• Job openings have not resulted in either job creation or wage growth, contradicting inflation fears.
• The Fed’s obsession with higher for longer rates has no solid ground, as inflation expectations are likely to be met within the next 9-12 months.
• With an oversold bond market, an overbought oil market, and expectations of record earnings, investors can still make a strong Bull Case for the market going forward.

Recent Spike in Long-Term Interest Rates & Market Weakness

Recently, stocks have fallen sharply in response to an increase in long-term Treasury yields, with the 10-year breaching 4.8% recently. The yield on the 10-year has risen a stunning 50 basis points in just the past two weeks.

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This selling has nothing to do with economic fundamentals, as inflation continues to decrease while the economic growth rate has started to slow, both of which should bring yields down. It has everything to do with misguided rhetoric from Fed officials who assert short-term rates may need to stay higher for longer to squash inflation. Therefore, any incoming economic data that is stronger than expected fuels fears of higher for longer, even when that data has little to no inflationary impact.

Increase in Job Openings Does Not Lead to Higher Inflation

For example, the consensus expected job openings were expected to fall from 8.82 million in July to 8.75 million in August. Instead, openings rose to 9.61 million, with most of the increase coming from professional and business services. Upon release of this report, yields soared, and stocks plunged, as though it guaranteed the well-entrenched disinflationary trend would stall. We have had an extraordinarily high number of job openings all year, but that is only relevant as it results in job creation and wage growth, which are primary drivers of inflation.

Job openings do not necessarily fuel inflation. When these job openings get filled with new workers the demand for goods and services will place upward pressure on prices through increased consumption. Despite the number of openings, job growth has slowed dramatically over the past year and fallen to just 150,000 new jobs per month on average over the past three months. As a point of reference, there is about 150,000 Gen Z workers entering the workforce monthly which means that new job creation is just equaling work force population growth.

Accordingly, if stubbornly high job openings are not leading to the creation of more jobs beyond population growth, then Fed officials and investors need to downplay the importance of that data point as a reason to maintain rates higher for longer.

Job Market Remains Strong Despite Higher Interest Rates

Understanding why the labor market has remained so strong could yield an idea of how long it could last. There is no satisfactory explanation for why, and the labor market’s resilience has confounded the Fed economists. We initially wrote about this topic in our June 30, 2022 note (“Recession Talk is Overstated”). We argued that healthy consumer spending fueled by high employment, heightened fiscal stimulus keeping labor demand strong in usually interest rate sensitive sectors such as construction, and robust small business creation are critical factors in labor employment resilience. Additionally, increased labor force participation rates are easing supply problems, which has helped to reduce labor price inflation. Finally, new technologies such as artificial intelligence are working to make workers more productive, allowing them to produce more for the same labor hours. Increasing productivity helps to keep a lid on labor price inflation.

Our unique Baby Boomer demographics are also creating labor demand and helping to keep employment figures high. Baby Boomers are now between 59 to 77 years old, with an average age of 68. They have been retiring in droves for some time now but are still young enough to be in the high-consumption phase of retirement.

Baby Boomer consumption creates end demand for products and services that need to be provided and manufactured by the relatively smaller labor pools of Gen X (43 to 58) and Millennials (27-42) workers. The oldest Gen Z cohort has entered the labor market, but my 13 and 10-year-old Gen Z daughters won’t (willingly) be entering the labor market for years to come. This massive group of consumers creates enormous demand, which needs to be fulfilled with smaller labor pools of younger demographic groups.

Talking Heads Rooting for Recession

Unfortunately, there are lots of naysayers who are rooting for a recession and another bear market. They either inaccurately forecasted both more than a year ago and didn’t want to be proven wrong, or they missed the rebound in mega-cap technology stocks, which began in October 2022, and have taken to the airwaves to talk down the market. They’re getting their wish recently and will take advantage of this opportunity to buy into these fantastic companies and take advantage of the next leg up in the market driven by these exceptionally profitable businesses with sustainable competitive positions.

The Obsession with 2% Inflation

The obsession with “higher-for-longer” rates has no solid ground to stand on. The Fed has largely accomplished its goal of achieving stable prices, and it is only a matter of months before this becomes clear in the inflation reports. Its failure to acknowledge such is intended to keep inflation expectations in check until official reports reflect that the Fed has met its numerical target of 2%. Excluding rent, the August consumer price index rose an annualized 1.9%, and the core rate rose 2.2%. Anyone can look at the new rental rates each month that are working their way into the annualized number and discern that the headline and core inflation numbers will be at the Fed’s 2% target within the next 9-12 months. Fed officials who argue otherwise are playing word games to manage inflation expectations and prevent financial conditions from loosening too soon.

Oil Prices Topping Resulting in Less Inflationary Impact

The other near-term development that has hurt the stock market has been rising oil prices. Rising oil prices will feed through to higher future PPI, CPI, and PCE inflation readings. They started growing in mid-June and have yet to look back. However, oil prices are topping at current levels, given waning demand in China and the Eurozone. On a go-forward basis, additional non-OPEC+ supply increases in Canada and Brazil are expected to come online in 2024. Lower oil prices will help reduce future inflation and interest rate expectations and, in turn, benefit equity markets.

Bond & Equity Markets Oversold

The major market averages are deeply oversold and due for a bounce. We will see a sizeable fourth-quarter rally that restores the gains we made just two months ago, and upcoming earnings reports should be the catalyst. Historically, the S&P 500 has declined four weeks in a row and remained above its 40-week moving average just 15 times since 1975. That’s the market we are in at present. The S&P 500 finished higher ten weeks later on 14 out of those 15 times. Those are good odds for a rebound this year and early 2024.

From a technical analysis standpoint, the bond market is oversold and could finally find technical support at the current level. Steady or decreasing rates would be a tailwind for equity markets if rates find some support here. Specifically for those large-tech names that led during the first half of 2023.

The recent equity market pullback has led to a contraction in earnings multiples (i.e., P/E ratios). But, earnings have not budged. As you can see from the chart below, we are still looking at record earnings expectations for the S&P 500 in 2023, 2024, and 2025. Realized earnings may not meet those expectations, but the market should trade on them for now.

Chart of S&P 500 earings
FactSet Research

With an oversold bond market, an overbought oil market, and expectations of record earnings, investors can still make a strong Bull Case for the market going forward.