Once a month, on the fourth Thursday of the month, I will put up a long term view of the market. This is provided for investors who don’t want to trade secondary swings in the market, but would like to exit the stock market relatively soon after a bear market begins, or enter the market after a new bull market begins (change in the primary trend). In the blog, they will always have a title called “Long Term (month) (year)”, so you can use your browser “Find” function and easily find them.
Economics:
GDP – The second estimate of 2023 Q2 GDP is +2.1% (revised down from _2.4%), following Q1’s +2.0%. Many economists think the long term growth rate of the US, without artificial stimulus, is about 2%.
The economy continues to expand at a rational normal rate. This is better than the erratic rates of 2020 – 2022. Inflation is coming down and although interest rates are relatively high the economy seems to be dealing with them fairly well.
This is bullish for the stock market.
| Year | Quarter | GDP % |
| 2023 | Q2 | 2.1 |
| 2023 | Q1 | 2.0 |
| 2022 | Q4 | 2.7% |
| 2022 | Q3 | 3.2% |
| 2022 | Q2 | -0.6% |
| 2022 | Q1 | -1.6% |
| 2021 | Year | 5.5 |
| 2020 – Covid | Year | 0.1 |
| 2019 | Year | 2.3 |
| 2018 | Year | 2.9 |
| 2017 | Year | 2.6 |
| 2016 | Year | 2.0 |
Fed interest rates – At the July meeting, the Fed increased the Fed Funds rate by .25% to 5.5%.
Powell was even handed in his assessment of the future. Inflation has come down but it needs to come down farther. But with interest rates being restrictive now, there is also risk to the economy that it will slow too much.
In August at Jackson Hole, Powell’s message was about the same as at the July Fed meeting.
The other thing the Fed is doing is Quantitative Tightening (QT), which means they are not buying bonds to replace those that they hold when they mature, and outright selling bonds into the secondary market. This will force private companies and individuals to buy the bonds, and then those dollars are not available to buy TV’s, boats, or other big ticket items. Money is going out of circulation shown by a outright decline in the M2 money supply, which does not happen often.
Local and regional banks have tightened lending standards making it harder for small and medium businesses to get loans to expand. That will slow the economy down somewhat.
You can see in the table below that interest rates ticked up at all durations in August, and the stock market corrected a little.
The next Fed announcement on rates is Sept. 20.
Fed policy is restrictive for the economy, and bearish for the stock market.
| Date | Fed Funds Rate | 5 Year Treasury | 10 Year Treasury | 30 Year Treasury |
| Aug 2023 | 5.5 | 4.4 | 4.2 | 4.3 |
| Jul 2023 | 5.5 | 4.1 | 3.9 | 3.9 |
| Jun 2023 | 5.2 | 4.0 | 3.7 | 3.8 |
| May 2023 | 5.2 | 3.8 | 3.7 | 4.0 |
| Apr 2023 | 5.0 | 3.5 | 3.4 | 3.7 |
| Mar 2023 | 5.0 | 3.6 | 3.5 | 3.7 |
| Feb 2023 | 4.7 | 4.2 | 3.9 | 3.9 |
| Jan 2023 | 4.5 | 3.6 | 3.5 | 3.6 |
| 2022 Q4 | 3.9 | 4.0 | 3.9 | 4.0 |
| 2022 Q3 | 2.5 | 3.4 | 3.3 | 3.3 |
| 2022 Q2 | 0.8 | 2.9 | 2.9 | 3.0 |
| 2022 Q1 | 0.2 | 2.0 | 2.1 | 2.3 |
| 2021 Year | 0.2 | 0.8 | 1.4 | 2.0 |
| 2020 Year | 0.4 | 0.6 | 0.9 | 1.6 – Covid |
| 2019 Year | 2.2 | 1.9 | 2.2 | 2.6 |
| 2018 Year | 1.8 | 2.8 | 2.9 | 3.1 – Tax Cut |
| 2017 Year | 1.0 | 1.9 | 2.3 | 2.9 |
Valuation:
S&P 500 earnings – Factset shows that for Q2 of 2023 with 84% of the S&P reporting (August 4th), blended earnings are -5% vs. Q2 of last year (-9% was projected last month). If that is how they come in, we would have Q4 2022 at -4%, Q1 2023 at -2%, and projected Q2 2023 at -5%, and that is not a pretty picture. It is unusual for earnings to show an outright year over year decline. Normal year over year earnings growth is about +5%. We are in an earnings recession.
The forward PE for the S&P is 19 compared to the ten year average of 17, but remember, the forward PE is just a guess and nobody’s guess has been very good lately. The bear market has done its job and brought the stock market from dangerous overvaluation 2 years ago, down to more normal valuations. The question is, will the interest rate hikes cause a recession in 2024 that will take the market valuation down from normal to attractive level, with a PE in the low teens?
The 12 month forward “operating earnings” estimate on the S&P 500 from the Standard and Poor’s company is $230, up $2 from last month.
The outlook for earnings is bearish, below the long term trend of +5%.
PE on S&P 500 – The current 12-month trailing GAAP PE on the S&P 500 is 24.4, down a bit from 25.4 last month and down from 31 in the summer of 2021. I used 4 quarters of earnings with the most recent being Q2 2022 (this data is 94% actual and 6% estimated earnings). The S&P corrected downward in August, so the valuation came down.
This metric is moderately overvalued relative to my trimmed 30 year average of 19. I trimmed out the quarters during recessions for my 30 year average, since the P/E behaves very abnormally during those times. I go in 5 point increments for my terminology, so 20 – 25 would be moderately overvalued, while 25 – 30 would be significantly overvalued. Above 30 would be dangerously overvalued. On the downside, I will go with 14-18 being moderately undervalued and 9-13 being significantly undervalued. As a last resort, I will go with 4-8 as being egregiously undervalued, and hope we never see that because all investors will be in pain at that point.
This indicator is bearish.
Age of primary move, bull or bear market – This bull market is 10 months old, started in Oct. 2022. The age is neither bullish nor bearish, but it is worthwhile to keep it in mind. Terminology here is complicated. I have written about secular (long term) trends vs. cyclical (short term) trends. 2022 was clearly a bear market, but was is a cyclical bear market in the long term bull market that started in 2009, or was it the start of a secular bear market? If it was the start of a long term bear market, it can be interrupted by a cyclical bull market. The one thing that keeps me open to the theme of a secular bear market beginning in Jan. 2022 was that the valuation, the PE on the S&P, peaked at 31, dangerously overvalued. That usually occurs late in a secular bull market.
Geo-Political: (no change from last month)
Liquidity: Central banks globally are withdrawing emergency accommodation for Covid. They are tightening financial conditions by raising interest rates to fight inflation.
US / China: It appears that the US and China are engaged in a tug of war to see who is the world’s economic leader. China has advantages in low cost labor and some natural resources such as rare earth metals, but they lack oil and natural gas. China developed the ability to produce advanced electronics with the aid of the US, but the primary market for those items is the US and Europe. The US has long been a technology leader and we have sophisticated financial markets that are usually well regulated. Another major factor is global alliances. The US has strong alliances with NATO, Canada, Japan, and S. Korea, while China has a strong relationship with Russia.
Ukraine: Thewar in Ukraine drags on. Ukraine is having more success on the battlefield than most expected, with the help of western weapons. Russia is destroying much of eastern Ukraine’s cities and rebuilding will be difficult. Sanctions against Russia are disrupting commodity markets since Russia was such a large exporter or oil, natural gas, and metals. Ukraine was a large exporter of wheat and other foods and that export is hindered by the war. It appears that after the initial shock in the commodity markets when Russia invaded, prices have stabilized and the world is dealing with new sources and trading patterns.
Geo-politics is currently bearish, mainly due to the war in Ukraine and global central banks tightening.
Technical:
Technically the chart below is positive near term (months), and still positive longer term (year).
RSI at the top of the chart is neutral at 60. Momentum shown by MACD at the bottom of the chart is positive and it has turned up. The price action is positive both near and longer term. There are two cautionary items on the chart. First, the price action is near the top of the uptrend channel of the last ten years. That will be resistance and you don’t have to rise that far to hit it. We broke above it in late 2020, but then the government was spending like drunken sailors since Covid broke out in March 2020. Second, we see a small downward correction started in August 2023. We rallied last week, but the downtrend can resume anytime.
Ten Year Chart of the S&P 500, each data point is one month’s price range.
This is positive in the short run, and remains bullish longer term.
Conclusion:
- GDP growth is bullish with Q2 GDP rising by 2.4%.
- The Fed has short term rates at 5.5%. That is restrictive and bearish.
- S&P earnings for Q2 are 5% below Q2 2022 which is below trend and bearish.
- The PE valuation of the S&P based on the 12 month trailing GAAP number is 24.4, which is moderately overvalued and bearish.
- The geo-political factors are bearish.
- Technically the chart looks bullish short term, and bullish longer term.
By that way of looking at it, the market is bearish, with four factors bearish and two bullish.
Long Term Issues to Keep in Mind:
National Debt:
(December 2022) – The national debt stands at $31.5 trillion.
(Updated March 2020) – Covid 19 begins. Well this is going to get a lot worse. Looks like the politicians are going to be printing money and dropping it from helicopters. But all the other major economies will do the same thing, so relatively, the dollar may not drop much (which would be bad for inflation).
(Negative – Noted Jan. 2018) The deficit will go up despite the republicans saying that if the tax cut bill is “dynamically scored” using “possible” increases in economic activity, it will hold down the deficit by increasing tax receipts. This has not been shown to work in the past. The US added $980 billion to the national debt in fiscal 2019 (ended 9/30/2019), a tragedy in good financial times.
(Late 2020) – The total national debt exceeds $26 Trillion, and as interest rates rise, the component of the annual budget allocated to “interest on the debt” will increase, putting pressure on existing programs, or increasing the deficit. If the deficit is allowed to rise too much in good economic times, the value of the dollar will fall and that is inflationary which is usually bad. The thing saving us today is how poorly all the other nations are managing their economies, so the dollar continues to hold up.
Rich Comeau, Rich Investing
Rich Investing 