Last Week in Review – August 21, 2023 – from Stephen Colavito
Stocks were broadly lower as sentiment appeared to take a blow from a sharp increase in longer-term bond yields and fears of a sharp slowdown in China. The S&P 500 Index ended the week down 5.15% from its July 26 intraday peak. Growth shares should theoretically suffer the most as rising rates place a more significant discount on future earnings. Still, the Russell 1000 Growth Index was modestly better than its value counterpart. Small-cap stocks performed the worst. Program trading, technical factors, and thin summer trading volumes may have accentuated the market’s swings.
US - MARKETS & ECONOMY
The notable economic release of the week appeared to be Tuesday’s report from the Commerce Department on July retail sales, which jumped 0.7% over the month, roughly double consensus estimates. Excluding the volatile auto segment, sales rose 1.0%, bringing their year-over-year gain to 3.2%. While retail sales were essentially flat over the past year, given the equivalent rise in the consumer price index, sales in specific categories indicated a sharp rise in discretionary spending. For example, sales at restaurants and bars jumped 11.9%, while online purchases surged 10.3%. Meanwhile, gas station sales plunged 20.8%.
Some of the week’s other data seemed to raise the prospect of a “no landing” scenario—the possibility that the economy would continue to expand without experiencing a “soft landing” slowdown or a “hard landing” recession. Industrial production grew by 1.0% in July, roughly triple consensus estimates and its biggest gain since January. However, part of the increase came from utilities boosting output to cope with July’s high temperatures. A gauge of manufacturing activity in the mid-Atlantic region indicated expanding factory activity, orders, and shipments for the first time in 14 months. Nationwide housing starts also rose more than expected.
The Wednesday release of the minutes from the Federal Reserve’s July policy meeting seemed to raise worries about how policymakers would respond to continued growth signals. Investors seemed to interpret the minutes' tone as generally hawkish, even as Fed officials expressed hopes that “a continued gradual slowing in real gross domestic product (GDP) growth would help reduce demand-supply imbalances in the economy.”
However, whether the economy was slowing and by how much may arguably have become less clear since the Fed’s meeting. The Atlanta Fed’s GDPNow forecast for growth in the current quarter, which is continually revised based on incoming data, jumped to 5.8% as of Wednesday, well above the official second-quarter growth rate of 2.4%. While most expect the actual growth rate in the third quarter to be substantially lower, the Atlanta Fed’s “Blue Chip” survey of economists indicated that most are also steadily revising their growth forecasts higher. Nevertheless, rate hike expectations, as measured by the CME FedWatch tool, remained roughly stable over the week, with futures markets pricing in the likelihood of rates staying at their current level through the end of the year.
US – EQUITY MARKET PERFORMANCE
US YIELDS & BONDS
The positive economic surprises pushed the yield on the benchmark 10-year U.S. Treasury yield to its highest level since at least October 2022. However, heavy issuance and, thus, supply worries may have also played a role. Tax-exempt municipal bonds were initially resilient to the heightened volatility in Treasuries, but muni yields jumped on Thursday. Nevertheless, new deals were well subscribed, as attractive new issue concessions appeared to bolster demand.
Investment-grade corporate bonds underperformed Treasuries throughout the week, led by the auto sector. Roughly half of the week’s issuance was oversubscribed, however. Meanwhile, market volumes in the high-yield bond and bank loan segments were somewhat below average, and our traders noted that much new issuance may be delayed until after the Labor Day holiday.
US TREASURY MARKETS – CURRENT RATE AND WEEKLY CHANGE
3 Mth +0.03 bps to 5.43%
2-yr: +0.18 bps to 4.94%
5-yr: +0.26 bps to 4.39%
10-yr: +0.22 bps to 4.42%
30-yr: +0.18 bps to 4.38%
INTERESTING NEWS OVERSEAS
In local currency terms, the pan-European STOXX Europe 600 Index fell 2.34% on intensifying concerns about the outlook for China’s economy and the prospect of a prolonged period of higher European interest rates. Major stock indexes also weakened. France’s CAC 40 Index slid 2.40%, Germany’s DAX lost 1.62%, and Italy’s FTSE MIB gave up 1.81%. The UK’s FTSE 100 Index dropped 3.48%.
UK wage growth accelerated, increasing the pressure on the Bank of England (BoE) to raise interest rates further. Average weekly earnings (excluding bonuses) climbed 7.8% in the three months through June—up from 7.4% in the three months through May. Signs of cooling in the labor market also emerged. The unemployment rate rose more than expected to 4.2% sequentially from 3.9% in the previous three months.
Annual UK inflation slowed in July to 6.8% from 7.9% in June, driven lower by falling energy and food prices. But underlying price pressures remained strong, with the core rate, which excludes food, energy, alcohol, and tobacco, staying at 6.9%. Services prices—seen by the BoE as the best predictor of underlying domestic inflation—quickened to 7.4%, the highest level since March 1992.
Amid concerns about the broader impact of China’s macroeconomic weakness and its troubled property sector, Japan’s stock markets declined over the week, with the Nikkei 225 Index down 3.2% and the broader TOPIX Index falling 2.9%. Share price weakness was notable among tourism-related names.
The yield on the 10-year Japanese government bond (JGB) rose to 0.64% from 0.58% at the end of the previous week. This follows the Bank of Japan’s (BoJ’s) monetary policy tweak in July to allow JGB yields to rise more freely by turning its 0.5% yield ceiling from a rigid limit into a reference point.
The yen weakened to about JPY 145.5 against the U.S. dollar, from around JPY 144.9 the prior week, trading around the nine-month low levels that prompted Japanese authorities to intervene in the foreign exchange market in September 2022 to stem the yen’s decline. Japan’s Finance Minister Shunichi Suzuki continued to assert that authorities are watching market moves with a strong sense of urgency and will respond appropriately, particularly to speculative moves that can potentially affect companies’ future planning and households’ prospects.
Chinese stocks lost ground amid pessimism about the country’s flagging economic recovery. The Shanghai Stock Exchange Index gave up 1.80%, while the blue-chip CSI 300 fell 2.58%. In Hong Kong, the benchmark Hang Seng Index plummeted 5.89%, its most significant weekly drop in five months, according to Reuters.
Official data for July revealed that China’s economic activity continued to weaken. Industrial output and retail sales grew slower than expected in July from a year earlier. Fixed asset investment growth in the first seven months of 2023 also missed forecasts. According to China's statistics bureau, Urban unemployment increased to 5.3% from June’s 5.2%. The bureau did not release the youth unemployment rate, which rose every month in 2023 and hit a record 21.3% in June. The decision to suspend the closely watched indicator raised concerns that Beijing was suppressing information that it deemed politically sensitive.
THE WEEK AHEAD
August flash PMI data will be unveiled next Wednesday for the earliest insights into economic conditions across major developed economies midway into the third quarter. On the central bank front, the Fed's Jackson Hole symposium will be eagerly anticipated for further Fed updates while monetary policy meetings unfold in South Korea and Indonesia. Other highlights to watch on the economic calendar include US durable goods data, GDP from Germany and Thailand, and CPI readings in APAC economies.
The July US Federal Open Market Committee (FOMC) meeting minutes have intensified rate hike concerns this week after Fed officials were observed to be considering more hikes in their bid to tame inflation. This comes just after the S&P Global Manager Index outlined easing monetary policy worries from July, suggesting that sentiment again shift before next month's update, ahead of the September 19-20 Fed meeting.
The August 24-26 gathering in Wyoming is expected to bring about a series of updates from central bankers. Even if no concrete direction regarding US monetary policy may be sought, the tone adopted can still influence market expectations. This is especially true as recent US PMI price indices pointing to subdued inflationary pressures compared to the post-pandemic peak indicate that inflation has remained rather sticky into the second half of 2023.
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.