Last Week in Review – August 14, 2023 – from Stephen Colavito
The major benchmarks ended mixed for the week as investors weighed inflation data against worries over the recent rise in long-term interest rates. Value stocks handily outperformed growth stocks, and the narrowly focused Dow Jones Industrial Average managed a modest gain. Volumes were generally light, reflecting both the summer vacation season and a seeming lull as the quarterly earnings reporting season wound down.
Healthcare shares got a boost at midweek from further evidence of the efficacy of diabetes drugs in treating obesity and related ailments, while information technology stocks underperformed on worries that rising rates would reduce the value of future profits. Industrials stocks were also weak on growing fears over a United Auto Workers union strike.
Financial stocks sold off briefly on Tuesday morning after Moody’s Investors Service lowered its credit ratings for ten small- and mid-cap banks and placed six other entities on downgrade watch. Moody cited funding costs and the bank’s exposure to the troubled commercial real estate sector. However, shares in the sector recovered to some degree as the week progressed.
US - MARKETS & ECONOMY
The week’s economic calendar was relatively light overall but included closely watched inflation data. On Thursday, stocks started trading on news that the Labor Department’s consumer price index (CPI) rose 0.2% in July, bringing its year-over-year increase to 3.2%, a tick below expectations. A sharp drop in airline fares helped compensate for continuing pressure from shelter costs.
Enthusiasm over the CPI data appeared to wane as the day wore on. However, stocks were mixed on Friday following news that producer prices rose 0.3% in the month, a tick above expectations. On a year-over-year basis, producer prices rose 0.8%, well below the Federal Reserve’s overall consumer inflation target of 2%. However, July marked the first annual increase in the producer price inflation rate in over a year.
The week also brought a somewhat mixed inflation outlook from Federal Reserve officials. Over the previous weekend, Fed Governor Michelle Bowman warned that further hikes might be needed, while New York Fed President John Williams suggested that rate hikes were nearing their end and that rate cuts might be coming as soon as 2024. On Tuesday, Philadelphia Fed President Patrick Harker said he was comfortable keeping rates steady. At the same time, Richmond Fed President Thomas Barkin suggested he also favor a pause in the hiking cycle.
US YIELDS & BONDS
The producer price report pushed the yield on the benchmark 10-year Treasury note higher to the end of the week. (Bond prices and yields move in opposite directions.) August reinvestment cash provided a tailwind to the municipal bond market. The muni primary calendar was active, and new deals were generally oversubscribed. The issuance in the investment-grade corporate bond market was also heavy throughout the week. The high-yield bond market also saw active trading in new issues, although volumes were generally somewhat light given the time of year.
US TREASURY MARKETS – CURRENT RATE AND WEEKLY CHANGE
3 Mth -0.01 bps to 5.40%
2-yr: -0.11 bps to 4.76%
5-yr: -0.05 bps to 4.13%
10-yr: +0.08 bps to 4.03%
30-yr: +0.19 bps to 4.20%
INTERESTING NEWS OVERSEAS
In local currency terms, the pan-European STOXX Europe 600 Index ended little changed. The Italian government’s decision to seek a windfall tax on bank profits and increasing concerns about a potential economic slowdown in China weighed on sentiment. Major stock indexes were mixed. Germany’s DAX fell 0.75%, Italy’s FTSE MIB tumbled 1.09%, and the UK’s FTSE 100 Index lost 0.53%. France’s CAC 40 Index, on the other hand, gained 0.34%.
European government bond yields rebounded from intra-week lows as investors weighed the possibility that inflationary pressures might remain elevated. The yield on the benchmark 10-year German government bond climbed above 2.50%. Swiss and French bond yields moved in tight ranges. The benchmark 10-year government bond yield in the UK ticked higher as robust economic growth data raised expectations that the Bank of England would continue to tighten monetary policy.
UK gross domestic product (GDP) grew 0.5% sequentially in June, exceeding a consensus forecast for a 0.2% expansion. Substantial increases in manufacturing and construction were essential drivers. Second-quarter GDP surprised to the upside, growing 0.2% versus the previous three months, thanks partly to better-than-expected private consumption. Business investment rose strongly as well, defying forecasts for a modest contraction.
The European Central Bank (ECB) said in its latest Economic Bulletin that, since the June interest rate hike, developments had supported the expectation that inflation should moderate in 2023 but still stay above the 2% target for an extended period. The publication indicated that the near-term economic outlook for the euro area had deteriorated due to weaker domestic demand. Even so, the ECB believes the inflation and economic growth outlook remains uncertain. The comments raised expectations that policymakers could pause monetary tightening in September.
Japan’s stock markets rose over a holiday-shortened week, with the Nikkei 225 Index gaining around 0.9% and the broader TOPIX Index up about 1.3%. Optimistic earnings forecasts from some significant Japanese companies provided a favorable backdrop. At the same time, tourism-related shares received a boost from news that China would approve the resumption of Japan-bound group tours for its citizens.
The yield on the 10-year Japanese government bond (JGB) fell to 0.58% from a nine-year high of 0.65% at the end of the previous week. A stronger-than-expected outcome of a 30-year bond auction during the week affected yield across the curve. The Bank of Japan (BoJ) tweaked its monetary policy in July to allow yields to rise more freely but has indicated that it will not tolerate a rapid move in yields. The yen weakened to around JPY 144.6 against the U.S. dollar, from about JPY 141.7 the prior week, as it continued to be weighed down by the country’s interest rate differential with the U.S.
Chinese stocks retreated as mounting evidence that the country’s recovery may have peaked weighed on sentiment. The Shanghai Stock Exchange Index declined 3.01%, while the blue-chip CSI 300 lost 3.39%. In Hong Kong, the benchmark Hang Seng Index gave up 2.38%.
China’s latest inflation data revealed that consumer and producer prices fell in tandem for the first time since November 2020, underscoring the weak demand throughout the economy. The consumer price index declined 0.3% in July from a year earlier and slipped into contraction for the first time since February 2021. The producer price index fell a worse-than-expected 4.4% from a year ago but slowed from June’s 5.4% decline. The release reinforced concerns that China has entered a deflationary period, which offset optimism about Beijing’s latest efforts to prop up demand after the State Council announced new measures last month to boost consumer spending.
In corporate news, Country Garden, one of China’s largest property developers, missed interest payments on two dollar-denominated bonds as it struggles with liquidity issues. The company expects to record a loss of RMB 45 billion to RMB 55 billion (USD 6.2 billion to USD 7.6 billion) in the first half of the year amid falling sales and rising refinancing costs, according to a statement released on Friday. The news from Country Garden, one of a few big developers that have yet to default, spelled more bad news for China’s property sector, which has been in a downturn for several years as cash-strapped developers have grappled with slowing sales and high debt levels.
THE WEEK AHEAD
In the US, investors will closely focus on the FOMC minutes for additional insights into the Fed's plans for the remainder of the year, although Chair Powell said last month that decisions would be made on a meeting-by-meeting basis. Markets are currently pricing in an 89% probability of the Fed holding interest rates in September, while the odds for a quarter-point hike in November now stand at about 32%. Meanwhile, the earnings season is closing, but Home Depot, Cisco, Walmart, Deere & Co, Target, and Applied Materials are among the companies set to announce their second-quarter results. On the data front, projections indicate a more rapid 0.4% increase in retail sales and a rebound in industrial production following a decline in June. Other important releases include consumer inflation expectations, building permits, housing starts, NY Empire State Manufacturing Index, Philadelphia Fed Manufacturing Index, and the NAHB housing index.
Have a great week.
Stephen Colavito
Chief Investment Officer
San Blas Securities
This message is informational and should not be construed as a solicitation or offer to buy or sell securities or other financial instruments. Past performance is not a guarantee of future results. San Blas Advisory is a registered investment adviser. More information about the firm can be found in its Form ADV Part 2, available upon request.