Last Week in Review – October 23, 2023 – from Stephen Colavito
Geopolitical concerns, tough talk from Federal Reserve officials, and a rise in long-term bond yields to new 16-year highs appeared to weigh on sentiment and drive the S&P 500 Index to its most significant weekly decline in a month. The Nasdaq Composite Index fared worst last week among the major benchmarks and nearly moved back into bear market territory, ending the week 19.91% below its early-2022 intraday highs. Relatedly, growth stocks lagged behind their value counterparts.
Stocks started the week on a solid note, marking the 15th straight Monday of gains for the S&P 500, seemingly helped by limited negative news flow regarding the Middle East over the weekend. Deepening tensions later in the week appeared to drain the gains, however. In particular, shares fell sharply on Thursday afternoon following reports that a U.S. Navy destroyer had shot down a cruise missile headed toward Israel. Reports of a drone attack on a U.S. base in Iraq also seemed to weigh on sentiment.
“Fedspeak” that was arguably less dovish than recent remarks from policymakers may have also been at work. Richmond Fed President Thomas Barkin told a real estate conference in Washington that he was “still looking to be convinced” that demand was slowing and cooling inflation. In comments before the Economic Club of New York on Thursday, Fed Chair Jerome Powell seemed to give a brief boost to sentiment after acknowledging “a clear tightening in financial conditions.” Still, The Wall Street Journal reported that markets pulled back sharply after Powell stated that he saw no signs that the current stance of Fed policy would push the economy into a recession.
US - MARKETS & ECONOMY
Some upside economic surprises may have reinforced worries that rates would remain “higher for longer.” On Tuesday, the Commerce Department reported that retail sales rose 0.7% in October, roughly double consensus expectations. The increase was particularly strong among online retailers and at restaurants and bars, indicating continued strength in discretionary spending. Over the preceding 12 months, however, sales rose 3.8%, roughly in line with consumer inflation. Meanwhile, weekly jobless claims surprised on the downside, falling below 200,000 for the first time since January.
Commerce data showed the industrial side of the economy remained considerably weaker, however. Overall industrial production increased by 0.3% in September but remained roughly flat over the preceding year (up 0.8%). The housing sector also demonstrated the impact of rising rates and the tight labor supply. September housing starts rose more than expected, but building permits, a more forward-looking gauge, fell 4.4% in the month, the sharpest decline in 10 months.
US – EQUITY MARKET PERFORMANCE
US YIELDS & BONDS
The 10-year U.S. Treasury note yield nearly touched 5% in intraday trading at the end of the week, reaching its highest level since July 2007. (Bond prices and yields move in opposite directions.) According to our traders, the tax-exempt municipal bond market weakened alongside Treasuries, with yields on AAA-rated municipal bonds moving higher while remaining volatile. Along with the sell-off in the Treasury market, primary issuance was heavy, which represented another strain on the secondary market. Demand for the new deals was generally adequate, however.
Banks dominated new issuance throughout the week in the investment-grade corporate bond market, and spreads widened only slightly despite the week of heavy issuance. However, the high-yield market came under pressure as tensions escalated in the Middle East. Weakness was felt across ratings and sectors, and below-investment-grade funds reported negative flows amid greater risk aversion. Conversely, the bank loan market seemed somewhat insulated from broader risk-off sentiment, seeing healthy demand for collateralized loan obligations alongside limited issuance.
US TREASURY MARKETS – CURRENT RATE AND WEEKLY CHANGE
3 Mth -0.03 bps to 5.45%
2-yr: +0.02 bps to 5.07%
5-yr: +0.22 bps to 4.86%
10-yr: +0.30 bps to 4.91%
30-yr: +0.32 bps to 5.08%
INTERESTING NEWS OVERSEAS
In local currency terms, the pan-European STOXX Europe 600 Index ended 3.44% lower amid uncertainty about the outlook for interest rates and fears that conflict in the Middle East could escalate. A spate of disappointing earnings reports worsened the risk-off mood. All the major Continental stock indexes also closed in the red. Italy’s FTSE MIB fell 3.12%, Germany’s DAX lost 2.56%, and France’s CAC 40 Index dropped 2.67%. The UK’s FTSE 100 Index declined 2.60%.
European government bond yields broadly climbed as investors weighed the prospect that interest rates could remain higher for longer due to sticky inflation. Germany’s benchmark 10-year government bond yield rose, ending the week shy of 2.9%. Italian bond yields also advanced, with the yield differential between German and Italian 10-year debt increasing above 200 basis points. In the UK, the yield on the benchmark 10-year government bond rose after inflation data came in as unchanged instead of slowing further.
Several European Central Bank (ECB) policymakers, including ECB President Christine Lagarde, Robert Holzmann of Austria, and Yannis Stournaras of Greece, highlighted the inflation risk posed by the rise in oil prices ignited by fighting in the Middle East. Meanwhile, ECB Chief Economist Philip Lane told a Dutch newspaper that the central bank may need to wait until the spring before it can be confident that inflation is returning to the 2% target. Bundesbank President Joachim Nagel echoed Lane’s comments, adding that price pressures remain “too high” in the eurozone, and “upside risks are still pretty present.”
Inflation in the UK unexpectedly held steady at an annual rate of 6.7% in September due to rising gasoline prices. Services inflation accelerated to 6.9%. Separate data showed that, in the three months through August, wage growth, excluding bonuses, rose 7.8% year over year—close to the record high. Bank of England (BoE) Chief Economist Huw Pill said before the data release that policymakers “still have some work to do” to ensure that inflation returns to the 2% target.
Japan’s stock markets fell over the week, with the Nikkei 225 Index down 3.3% and the broader TOPIX Index declining 2.3%. This was against a slight easing in inflationary pressure in Japan, although wage growth was in focus amid signs of a move toward higher pay demands for next year.
The latest messaging from the U.S. Federal Reserve indicated that interest rates would remain higher for longer, prompting a surge in bond yields. The 10-year Japanese government bond yield rose to 0.83%, its highest level in around ten years, from 0.76% at the end of the previous week. The Bank of Japan (BoJ) adjusted its yield curve control policy parameters in July, effectively allowing yields to rise more freely but capping them at 1%. In a sign that the central bank wants a gradual rise in yields and no sharp moves toward its ceiling, it again intervened during the week to slow the pace of increases, announcing an unscheduled bond-purchase operation.
The yen traded within the upper end of the JPY 149 against the U.S. dollar range, hovering near the JPY 150 threshold that many anticipate could prompt Japanese authorities to step in to stem the yen’s slide. The government again stated that it is prepared to intervene in the currency markets if it detects an excessive swing in exchange rates. If no action is taken, such an excessive swing can cause harm to the real economy as regular people and businesses suffer.
THE WEEK AHEAD
We are entering one of the busiest weeks on the earnings calendar, with major tech firms such as Alphabet, Microsoft, Meta, and Amazon set to release their results. Other big companies to watch include 3M Co, Coca-Cola, General Motors, Spotify, Verizon Communications, Snap, Visa, Mastercard, Automatic Data Processing, Boeing, CME Group, Merck & Co, Ford Motor, Intel, Chevron, and Exxon Mobil. Turning to the economic calendar, the US will publish the advance estimate of third-quarter GDP, along with September’s personal outlays and income. The US economy is expected to expand by an annualized rate of 4.1% in Q3, marking an acceleration from the 2.1% growth in the previous quarter, due in part to robust consumer spending and increased private investment. It is anticipated that core PCE prices will have risen by 0.3% in September, a slight increase compared to the 0.1% gain observed in August. The report is also expected to reveal a 0.3% increase in consumer spending and a 0.4% income increase for the same period. Furthermore, investors will closely monitor September's durable goods orders, the flash S&P Global PMI survey, new and pending home sales, the Chicago Fed National Activity Index, the advance estimates of wholesale sales and the goods trade balance, as well as the final reading of the Michigan consumer sentiment.
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.