As we reflect upon the past quarter, the imagery of Otis Redding’s “(Sittin’ On) The Dock of the Bay” echoes our market narrative. Much like Redding watching the ships roll in and away again, investors too are observing the market’s fluctuation. But unlike the tranquility of Redding’s narrative, our vigil at the dock can feel less peaceful. The current high interest rate environment will continue to exacerbate the market’s unpredictable nature. However, even with the likelihood of continued volatility, the market continues to trend upward. In this GreenUp Wealth market update, we will touch on the undercurrents that have largely propelled this rolling expansion: better-than-expected economic data, robust corporate earnings, and uplifting consumer financials.
The tides of Monetary and Fiscal Policy have shown differing rhythms over the past quarter and year. On one hand, Monetary Policy, with its restrictive posturing (the Fed raising the Federal Funds Rate by 5% in just over a year), has depressed potential inflation through higher interest rates dampening economic activity. On the other hand, Fiscal Policy, such as the $1.2 trillion Infrastructure Investment and Jobs Act, has acted as a strong current, pushing liquidity into the market and spurring growth. Through these contradictory actions, we have seen better-than-forecasted gross domestic product (GDP) figures in the United States.
Corporate Earnings: Cresting Higher Than Expected
During the early part of 2023, the majority of economists forecasted a still or receding tide with flat or negative GDP growth. We were pleased that GDP posted a better-than-expected first quarter, marking a 2% growth followed by a 2.1% ascent in the second quarter of 2023 as well as a promising third quarter GDP tracking at a robust 4.9%. However, better-than-expected growth can be a double-edged sword—prosperity generally carries some measure of inflation. Unexpected growth also signifies that the Federal Reserve will anchor interest rates higher for a longer time frame.
At the same time, we have also been mired in an earnings recession (defined by two consecutive quarters of earnings decreases), marking the third consecutive quarter of such a trend when compared to the previous year.
Despite the current earnings recession and a negative third quarter (when the S&P 500 Index dropped 3.6%), the S&P 500 has increased 13% year-to-date. The reason for the positive US stock market performance is because of a cascade of better-than-expected results. As we look to the latter half of 2023, economic tides continue to shift in a favorable direction. It is anticipated that Q2 2023 marked the cessation of the Earnings Recession. We foresee a trough in Q3 with modest growth ranging from 0.2% to 3.5% — perhaps a prelude to above-average earnings of 11.1% to 12% for 2024. Much like the tide that eventually ascends after a gradual retreat, corporate earnings growth appears to have found its footing.
The Consumer: An Economic Anchor
The better-than-anticipated upward momentum in corporate earnings parallels better-than-expected consumer health and activity. The employment situation in the United States has been substantially better than forecasted, with an unemployment rate of 3.8% paired with a deep pool of 8.8 million job openings as of July 2023. At GreenUp, we continue to be mindful of the pros and cons of wage inflation; that said, a 4.6% increase in wages when compared to June of 2023 is certainly welcome. In addition, wage increases are finally outpacing the annual inflation rate (as measured by the Consumer Price Index or CPI) at 3.7%. This positive difference means that our wages are increasing at a greater rate than the cost of goods and should give the consumer some much-needed reprise from the sudden increase in inflation experienced over the last 18 months.
These data points should indicate consistent consumer spending which represents 68% of economic growth in the U.S. But not all waters are tranquil. The surplus in consumer savings stimulated by government-sponsored pandemic stimulus continues to dwindle, and consumer debt is likely to increase. Higher consumer debt during a period of high interest rates will likely be a downward pull on the economy. Even as this unfolds, consumer sentiment tells a different story: the story of a consumer who is stressed but feeling measurably better about their financial situation than six months ago. This increased sentiment, buoyed by an accommodating job market, leads GreenUp to believe in continued consumer spending. Amidst the soft hum of Otis Redding’s melody, we see consumers, much like ships against the gentle stir of the bay, persisting against and benefiting from the inflationary tide.
Summary: Reflecting on the Dock of the Bay
Inflation has moderated at 3.6%, a bit shy of the Federal Reserve’s 2% target. Historically, an inflationary environment of 0-4% has yielded optimum market performance net of inflation across fixed income and stocks. Although the rate of inflation has accelerated at an unsettling rate through all of 2022, it has slowed in 2023 to a manageable rate, especially when paired with the current favorable economic data, robust corporate earnings, and buoyant consumer financials.
Despite the interest rate scenario, we maintain a hopeful outlook. The recent robustness in stocks and fixed income reinforces our anticipation of growth amidst the challenging but still fruitful economic landscape. Market volatility may not instill the same serene feeling from Otis Redding’s “(Sittin’ On) The Dock of the Bay,” but with the right financial and investment plan, volatile markets are simply the waves we encounter as we sail to our destination.
In the backdrop of a melodious Otis Redding tune, the market scene from July 1 to September 30, 2023 unfolded with a mixed rhythm. Major indexes, represented in ETF form, resonated with a somber tone:
- S&P 500 Index: -3.6%
- MSCI EAFE: -4.7%
- MSCI Emerging Markets Index: -3.7%
- Russell 2000 Index: -5.5%
- iShares Core U.S. Aggregate Bond ETF (AGG): -2.08%
This performance echoed the market’s unpredictable cadence under high interest rates, yet as the quarter wrapped up, the tune of an upward market trend hummed softly, in harmony with promising economic indicators.
GreenUp Portfolio Updates
We shifted half of the Avantis Emerging Markets Equity ETF (AVEM) exposure to WisdomTree India Earnings ETF (EPI) in response to growing confidence in the Indian market.
We replaced Parnassus Value Equity Fund (PARWX) with iShares S&P 500 Value ETF (IVE) to draw down risk and aim for a better alignment with benchmark standards.
Large Cap Stock Model
We increased our holdings in Alphabet Inc. (GOOG), Microsoft Corporation (MSFT), Booking Holdings Inc. (BKNG), Chevron Corp (CVX), and Becton Dickinson and Co (BDX). New entries include Deere & Co (DE), CSX Corporation (CSX), Meta Platforms Inc. (META), Omnicom Group Inc. (OMC), Apple Inc. (AAPL), and Analog Devices Inc. (ADI).
We reduced our holdings in Berkshire Hathaway Inc. Class B (BRKB), Charles Schwab Corporation (SCHW), Visa Inc. (V), Diamondback Energy Inc. (FANG), IQVIA Holdings Inc. (IQV), and Taiwan Semiconductor (TSM), and removed Comcast Corporation (CMCSA) from the portfolio.
Equity Income Model
We sold Pfizer Inc. (PFE) because of trailing performance and bought Gilead Sciences Inc. (GILD) which shows promising growth prospects attributed to strong Free Cash Flow generation.