Equities Start to Price in Higher Interest Rates
Photo Credit: Bee Felten-Leidel, Unsplash
Weekly Market Recap for October 27, 2023
While the Q3 surge in Treasury yields caused stocks to trade lower, equities and other risk assets showed surprising resilience considering the rate of change. The chart below compares the rise in the 10-year real yield, which is inverted, against the S&P 500's next 12-month P/E (price to earnings) multiple. The chart shows that P/E multiples historically contract as real yields rise; however, over the past 12 months, the S&P 500's P/E multiple rose along with real yields, deviating from historical norms. As outlined in the 4Q23 AA Guide, our primary concern is that risk assets face the potential for more downside as the market adjusts to the reality of higher rates. This week's sell-off partially narrowed the gap, but further downside risk remains.
S&P 500 Next 12-Month P/E vs 10-Year Real US Treasury Yield
2023 Third Quarter Initial GDP Estimate
In Q3 2023, U.S. GDP grew at a 4.9% annual rate, a significant increase from 2.1% in Q2 and 2.2% in Q1.
Compared to Q2, the rise in real GDP (gross domestic product) during Q3 reflected accelerations in consumer spending, private inventory investment, federal government spending, and a rebound in residential fixed investment. Slowdowns in nonresidential fixed investment and state and local government spending partly offset these increases. Overall, Q3 was the strongest quarter of GDP growth since 4Q21, when consumer spending and private inventory restocking caused real GDP to surge by 7%.
2023 Q3 Contributions to US GDP Growth
Durable Goods Orders Highlight Industrial Strength
Durable goods orders rose 4.7% in September, driven by a 93% surge in commercial aircraft orders. Excluding the volatile transportation segment, core durable goods orders rose a modest 0.5% in September (Figure 3). The rise in core durable goods orders showed that business investment increased for a second consecutive month and underscored the U.S. manufacturing sector's continued resilience despite higher rates and still-elevated inflation.
Core Durable Good Orders
New Home Sales Rise to 19-Month High
New single-family home sales surged 12.3% in September, reaching their highest annualized rate since February 2022. Separately, the pending home sales index unexpectedly rose 1.1% in September. The increases in new home sales and pending home sales indicate that home demand remains strong despite the average 30-year fixed-rate mortgage approaching 8%. However, it needs to be clarified whether this strong demand can last with high mortgage rates, decreasing affordability, and keeping home inventories tight. To provide more context, the pending home sales index remains near a record low.
New Home Sales (Thousands)
US Economic Strength
The U.S. economy remains resilient despite higher interest rates. Last week's Weekly Note discussed the limited impact that the Fed's rate hikes are having, with only interest-rate-sensitive sectors feeling the effect. Unless consumers or businesses need to borrow, their finances are only marginally impacted by higher interest rates. This dynamic is slowing the transmission of monetary policy into the real economy and contributing to the continued strength of consumer spending and business investment. However, it also gives the Fed more reason to keep interest rates higher for longer and continue shrinking the balance sheet via quantitative tightening.
Is the Labor Market Softening?
Initial jobless claims declined in recent months and remain low by historical standards. In contrast, over the past month, continuing jobless claims rose. The divergence highlights two labor themes we are monitoring. First, low initial claims suggest companies are hoarding labor. Second, rising continuing claims suggest individuals are taking longer to find new jobs, which is contributing to rising unemployment. The risk is that conditions deteriorate and companies stop hoarding labor, which could quickly push unemployment above 4%. Will the Fed tolerate higher unemployment or respond with rate cuts? The Fed will initially accept higher unemployment, but only to a certain extent. We can envision a scenario where the Fed implements a few rate cuts in late 2024, but that's quite a ways off, and a lot can change.
Initial US Jobless Claims (In Thousands)
Continuing US Jobless Claims
Important Disclosures
This material is provided for general and educational purposes only and is not investment advice. Your investments should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities, or investment-related service or product, including any investment product or service described in these materials.
Our Insights
