Mid-Quarter Market Update

As we sadly and far too quickly enter the tail end of summer, economic data in the U.S. continues resilient.  A full-blown recession remains elusive.  In fact, U.S. gross domestic product (GDP) growth reaccelerated in the second quarter to 2.4% annualized, favorably led by business investment and positive consumer spending. Labor remains strong, though slowing, as the economy added 187,000 jobs last month.  Despite increased volatility in the quarter, equities sit unchanged from the end of June.  Bonds, on the other hand, started the quarter with a sharp selloff.
 
Early this year, the "average" bond gained nearly 4% but has since lost all but about 1% of that move.  July saw Treasury yields begin to increase.  As yields rise, bond prices fall.  In our view, the recent spike results from an expanding supply of bonds. All else equal, as supply increases, prices tend to fall.  With US government fiscal deficits projected at 6.5% of GDP for fiscal year 2023, the Treasury is issuing a record amount of bonds to finance government expenditures.  Until now, except during recessions, wars, and pandemics during which fiscal stimulus was needed to prop up the economy and the populace, we haven’t experienced deficits of this magnitude.  The Bank of Japan's decision to allow their yields to rise for the first time in decades also complicates concerns about finding U.S. debt buyers.  Japan is a large buyer of U.S. Treasuries; any change could be significant.  Consequently, Treasury yields are rising to attract buyers.
 
Despite these challenges, we don't see yields moving much higher from current levels.  Many factors should keep them in check.  Negative news regarding supply dynamics appears priced in.  Inflation should continue to decline as the Fed's policy tightening works its way through the economy.  Thus, with yields at current levels, prospects for future returns are promising.  With an average yield close to 7%, bonds in portfolios may drive portfolio returns over the remainder of the year.  

The "rolling recession" scenario continues to play out.  A hard landing has already occurred for some segments like housing, manufacturing, and consumer-oriented goods.  We expect a continuation of the “roll through” with stabilization in these areas offset by weakness in areas of more strength.  Though forward economic indicators are a mixed bag, we will highlight one below:  
 

 
Source: Charles Schwab, The Conference Board's Measure of CEO Confidence, as of 8/3/2023.

Confidence amongst CEOs was one of the first areas to slip into recessionary signals last year.  However, executives are increasingly optimistic that the worst may be behind us.  We would agree with them.  Second quarter company earnings saw profits contract, but less than expected.  The third quarter seems to be setting up for a slight rebound.  Barring intensified geopolitical concerns and weaponized trade policies, a continued improvement should bode well for businesses.

As always, thank you for your continued trust.  We hope you enjoy the remainder of the summer.  Please call if you want to discuss your portfolio's investment strategy in more detail or just check in to catch up.