Tom Wald, CFA®, Chief Investment Officer, Transamerica Asset Management, Inc.
In this article we review:
A series of important economic data points released during the final week of August
The potential impact of this news on the markets and Federal Reserve monetary policy
Our expectations regarding overall economic trends between now and year-end 2023
Our perspectives regarding the stock and bond markets between now and year-end 2023
As students headed back to school and football returned to the gridiron, a host of economic data descended upon the markets in summer’s final week, adding to an ongoing backdrop of economic resilience yet ongoing market uncertainty. As the historically more volatile autumn months now await, we believe the following points are of importance to investors:
Inflation comes in slightly better than expected and well below peak levels. The Federal Reserve’s preferred inflation metric, personal consumption expenditures (PCE) core inflation, for the month of July saw an expected year-over-year blip upward to 4.2% (vs. 4.1% in June), though lower than consensus expectations of 4.3%. This continues along a slow but steady decline from the core PCE peak of 5.4% in February 2022. All considered, the longer-term trend continues, in our view, to appear encouraging, and we believe PCE core inflation will likely reach the 3% level during 1H 2024.
Gross domestic product (GDP) growth for 2Q revised downward but is still solidly positive. The Bureau of Economic Analysis (BEA) released its second estimate for 2Q GDP at 2.1% annualized growth, which was 0.3% below its first estimate released in July. Economic growth through 1H 2023 is now progressing right at the 2% level and while stronger than where most had anticipated it would be several months ago, it still could prove vulnerable to the lagging impacts of higher interest rates and potentially slowing consumer spending.
3Q GDP growth is currently tracking hot but is likely to cool down. The Atlanta Fed tracking estimate for 3Q GDP finished August at a blistering pace of 5.6%. However, we believe this measure will probably be declining between now and when the BEA releases its first advanced estimate on the quarter’s economic growth in late October. It is important to recognize this evolving estimate is not a forecast and has likely been skewed so far by strong seasonal consumer spending subject to decline between now and quarter-end.
Job growth is solid, but trends are now clearly slowing. While the Bureau of Labor Statistics’ August non-farm payrolls report remained strong at 187,000 new jobs added to the economy, this was largely neutralized by negative revisions to June and July totaling 110,000. This now puts the three-month rolling average for employment gains at 150,000 and noticeably trailing the six-month rolling average of 194,000 and 12-month average of 257,000. The unemployment rate also rose to 3.8%, its highest level in 18 months.
Fed policy remains in flux, however an end to rate hikes is in sight. At the Fed’s Jackson Hole Symposium, Chair Jay Powell reiterated the Fed’s conviction of maintaining its long-term inflation target at 2%, as well as its data-dependent stance in working to achieve that objective. In stating specifically, “We will proceed carefully as we decide whether to tighten further or, instead, to hold the policy rate constant and await further data,” the Fed looks to be leaving doors open to either ending its tightening cycle at the current federal funds rate target range of 5.25%–5.00% or raising it once more by one-quarter of a point.
Looking forward, we believe it is also important for investors to consider the following perspectives:
The economy could slow meaningfully in 4Q 2023. Declining and potentially negative GDP growth could occur in 4Q 2023, driven by the lagging effects of the Fed’s previous rate hikes yet to fully filter through the economy and potentially declining consumer spending levels resulting from the depletion of excess savings, rising aggregate consumer credit debt now topping $1 trillion, and the resumption of student loan payment requirements and interest accrual.
Traditional indicators are still flashing recession warning signals. Here we point toward the Conference Board Leading Economic Index® (LEI), which has experienced 16 consecutive months of decline, and the 3-month to 10-year Treasury bond yield curve, which has been inverted since last October. Both a declining LEI and an inverted 3-month to 10-year yield curve have a long history of preceding recessions.
We continue to believe the Fed is more likely to hold off on raising rates further between now and year-end. While markets are pricing in another quarter point hike as close to an even probability, we believe it is unlikely the Fed will do so at the upcoming September meeting and that weakening economic data will probably dissuade it from doing so in November and December. That said, we do not see the Fed cutting rates until about 2H 2024.
Long-term interest rates have recently spiked but we believe they could fall by year-end. While the 10-year Treasury yield recently eclipsed 4.3%, we expect that rate to fall to sub-4% by year-end as weaker economic data comes to the forefront. Thereafter, we believe investors should expect the yield curve to steepen back into an upward slope during CY 2024.
We see stocks as somewhat range-bound for the remainder of CY 2023 but with a strong upward bias in CY 2024. Given economic uncertainty as well as the strong year-to-date performance in stocks through September 1 (S&P 500® +19%), we are maintaining our year-end 2023 price target on the S&P 500 of 4,600. In looking ahead from there, we believe there could be meaningful upside in CY 2024 based on declining rates of inflation, the Fed’s conclusion of its tightening cycle, and better than expected corporate earnings as the economy recovers from a potentially moderate or shallow recession.
We see bond investors best positioned in middle of the curve investment-grade and high-yield bonds. With investment-grade bonds averaging yields of about 5.7% (ICE BofA Corporate Index effective yield August 31) and high-yield bonds offering approximately 8.3% (ICE BofA High Yield Index effective yield August 31), we view bonds of these categories in the 5- to 8-year maturity range as best capable of providing income and mitigating against both duration-based price risk and reinvestment risk.
Investments are subject to market risk, including the loss of principal. Asset classes or investment strategies described may not be suitable for all investors.
Past performance does not guarantee future results. Indexes are unmanaged and an investor cannot invest directly in an index.
Equities are subject to market risk meaning that stock prices in general may decline over short or extended periods of time.
Fixed income investing is subject to credit rate risk, interest rate risk, and inflation risk. Credit risk is the risk that the issuer of a bond won’t meet their payments. Inflation risk is the risk that inflation could outpace a bond’s interest income. Interest rate risk is the risk that fluctuations in interest rates will affect the price of a bond. Investing in floating rate loans may be subject to greater volatility and increased risks.
Growth stocks typically are particularly sensitive to market movements and may involve larger price swings because their market prices tend to reflect future expectations. Growth stocks as a group may be out of favor and underperform the overall equity market for a long period of time, for example, while the market favors “value” stocks. Value investing carries the risk that the market will not recognize a security’s intrinsic value for a long time or that an undervalued stock is actually appropriately priced.
Investments in global/international markets involve risks not associated with U.S. markets, such as currency fluctuations, adverse social and political developments, and the relatively small size and lesser liquidity of some markets. These risks may be greater in emerging markets.
The information included in this document should not be construed as investment advice or a recommendation for the purchase or sale of any security. This material contains general information only on investment matters; it should not be considered as a comprehensive statement on any matter and should not be relied upon as such. The information does not take into account any investor’s investment objectives, particular needs, or financial situation. The value of any investment may fluctuate. This information has been developed by Transamerica Asset Management, Inc. and may incorporate third-party data, text, images, and other content to be deemed reliable.
Comments and general market-related projections are based on information available at the time of writing and believed to be accurate; are for informational purposes only, are not intended as individual or specific advice, may not represent the opinions of the entire firm, and may not be relied upon for future investing. Investors are advised to consult with their investment professional about their specific financial needs and goals before making any investment decisions.
The 10-Year U.S. Treasury bond is a U.S. Treasury debt obligation that has a maturity of 10 years.
S&P 500® Index: An unmanaged index of 500 common stocks primarily traded on the New York Stock Exchange, weighted by market capitalization.
LEI consists of 10 components that indicate the short-term future course of various sectors of the economy, combined into a composite indicator of general economic performance.
The ICE BofA U.S. High Yield Index tracks the performance of U.S. dollar denominated below investment grade rated corporate debt publicly issued in the U.S. domestic market.
Transamerica Asset Management, Inc. (TAM) is an SEC-registered investment adviser. The funds advised and sponsored by TAM include Transamerica Funds and Transamerica Series Trust. Transamerica Funds and Transamerica Series Trust are distributed by Transamerica Capital, Inc. (TCI), member FINRA. TAM is an indirect wholly owned subsidiary of Aegon N.V., an international life insurance, pension, and asset management company.
