MARKET UPDATE AUGUST 2023

SUMMARY:

• The 2023 rally in the stock market stalled out last week.

• But we are still sitting well above the lows reached in October of 2022 and are still close to the all-time highs in the S&P 500.

• Small cap stocks have not rebounded as much and are still well below their all-time highs.

• The major stories are still the same – interest rates, inflation, and recession concerns.

• Recent trends in interest rates are not positive for the stock market.

• The trend in interest rates and the fact that stocks are approaching a key resistance level (all-time highs) we can expect a lot more volatility in the markets in the short term.

At nineteen months into this bear market of 2022/2023, it is a good time to step back and get some perspective. 2023 has been a good year for both the S&P 500 and the Nasdaq. As of the market close on Friday August 4th, the S&P 500 is only down about 6% from its previous peak at the start of the 2022. The Nasdaq is down about 12% from its all-time high and the Russell 2000 is still down around 20%. In the graph below, you can see the nice bounce off of the October 2022 lows and the slight reversal last week.

The stock market decline last week (7/31 to 8/4) was all about interest rate fears. The rating agency, Fitch, downgraded the credit rating of the United States. This is very unusual and hasn’t happened in a long time. They raised concerns about political disfunction and the inability of the government to deal with government debt among other things. Downgrades like this result in higher interest rates on government bonds.

This bear market has been driven by inflationary pressures and its resultant impact on interest rates. While the Fed seems to be nearing the end of its rate raising cycle, the debt downgrade has introduced another factor into the interest rate outlook.

A nice way to track bonds and interest rate trends is by looking at bond prices. Remember that bond prices move in the opposite direction of interest rates. When interest rates rise, bond prices go down and vice versa. And the cleanest way to track bond prices is by looking at zero coupon bonds. Since zero coupon bonds don’t pay any interest, the total return on these bonds is reflected in the price of those bonds. We use the symbol ZROZ to track bond prices.

In this first chart of the price for ZROZ, you can see the deep and steady decline of bond prices since the start of the stock market decline at the beginning of 2022. While the price for ZROZ seemed to bottom in October of 2022 like the stock market, its rebound has stalled out. ZROZ is still down about 50% from the end of 2021.

Let’s take a closer look at the price of ZROZ since the end of 2022. From the bottom in October of 2022, ZROZ climbed quickly from $80 to almost $100 in December of 2022. And since the beginning of April 2023, ZROZ has declined steadily back to the lows of October of 2022. Again, this is due to the upward pressure on interest rates (the Fed, inflation, debt downgrade).

The stock market rebound continues to be dependent upon the trend in interest rates. If rates continue to climb, stock prices will suffer. The bond market is currently experiencing the largest short position ever. This means that hedge funds and other traders believe that interest rates will continue to rise and bond prices will continue to drop. This also signals more price volatility in both stocks and bonds.

The reality is that no one knows if the worst is over or not. The last time there was such a high short position in bonds, bond prices and stock prices increased. Because of the uncertainty, it is important to follow a disciplined approach to investing. Followers of our Market Signals newsletter are positioned to benefit if the market keeps moving higher and will be able to limit losses if the market turns down from here. It is critical to have an investing strategy that wins no matter which way the market moves. No one can predict which way things will move in the short term. But we all know that in the long term, the direction of the stock market will be higher. Stay disciplined, my friends.

Happy Investing,

Phil

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Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.