Monthly Economic Review: August 2023

April 12, 2024

September 14, 2023

By

Conway Wealth

Both equity and fixed-income markets fell in August. The S&P 500 fell -1.6% as all sectors were down except for Energy, which rose 1.8%. Utilities fell the most (-6.2%), followed by Consumer Staples (-3.6%), Materials (-3.3%), and Real Estate (-3.0%). The Small-cap Russell 2000 index fell -5.0%. Yields on U.S. 10-year Treasuries rose for the fourth straight month reaching 4.1%, though mid-month levels reached 4.36%. The 5-year U.S. treasury rose towards 4.5% before retreating to 4.2% by month end. Within fixed-income markets, the Bloomberg U.S. Aggregate Bond Index fell for the fourth month in a row (-0.6%), U.S. Corporate HY Bonds rose 0.3%, and Municipal bonds fell -1.4%.

During the Federal Reserve’s Jackson Hole Symposium, its’ annual policy conference, Chair Powell indicated that while inflation has moved down from its peak, “it remains too high” and that returning to the 2% target will “require a period of below-trend economic growth as well some softening in labor market conditions.” Powell further indicated that he would like to see sustained progress on reducing goods inflation. With regard to future growth, he stated: “there may be significant further drag in the pipeline.” While he did not indicate if the Fed would achieve a soft landing, he did reiterate that the current rate is restrictive and confirmed that policy would return to being data-dependent. A drag in growth, however, does not appear to be the case this quarter. According to the Atlanta Fed’s GDPNow estimate, U.S. GDP is forecasted to grow 5.6% in the third quarter. This rate is well above the trend and has been driven by strength in manufacturing, retail sales, and housing starts.

Looking forward, per the CME Fed Futures market, investors forecast that the Fed Funds rate will remain unchanged for the remainder of the year at 5.25% to 5.50%. By year-end 2024, futures markets predict that the Fed is likely to reduce rates by an estimated 75 basis points towards 4.5%. If this forecast holds, rates will remain at their highest levels since the 1999-2000 period.

Within fixed-income markets, the curve remains deeply inverted with short-term treasuries still offering the highest yield, peaking at the 3-month term with a yield of 5.56%. The 1-year U.S. treasury is at 5.37%, then yields drop to 4.85% for the 2-year and 4.23% for the 5-year. During the month, credit rating agency Fitch downgraded U.S. credit from AAA to AA+. The near-term impact seemed muted as neither rates nor credit spreads moved notably in response to the downgrade. Credit spreads for both investment grade and high-yield corporate bonds remain in line with historic ranges from prior cycles and are not yet near recessionary levels. Inflation expectations remain contained with 5-year breakeven rates holding steady at 2.2%, very near the Fed’s long-term target of 2%. Given the rise in long-term rates, extending duration, especially for investment-grade bonds, provides a reasonable risk-reward trade-off.

Corporate earnings were in line with expectations, but growth levels were mixed. In general, earnings across consumer-facing firms were weaker while earnings across enterprise technology and industrials were stronger. Notably, analysts have begun to raise estimates again. After cutting expectations over the past year, Q3 and Q4 2023 EPS estimates have been revised higher as have forecasts for 2024. With the S&P forward PE multiple near 19x, and given the rate backdrop, it is likely difficult for the multiple to expand further from here.

Globally, economic growth rates are mixed. Growth in China continues to struggle with Q3 GDP estimates expected to come in at 4.6%, versus 6.3% from the prior year. Expectations are for weaker growth in areas like manufacturing, production, and energy utilization. Eurozone GDP for Q2 came in flat compared to the previous quarter. France and Spain grew slightly at 0.5% and 0.4% respectively, while Germany was flat and Italy declined at 0.3%. GDP growth for Japan increased by 1.5% QoQ, which is the fastest expansion since Q4 2020.

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Initial 2021 Tax Considerations

With the swearing-in of a new President and Vice President, plus convening of the next Congress, affluent Americans are weighing how changes in federal government may financially impact them.

Given that Democrats hold the Presidency and control both Houses of Congress by a slim margin, it now seems likely that tax reform could be passed as a budget reconciliation bill and then signed into law. While there is a remote chance that expected tax changes will be retroactive, it is more probable that they would take effect immediately upon becoming law or even at the start of 2022.

Since 2021 may be a last opportunity to capitalize on current income, capital gains, and transfer tax laws, families are considering key financial & estate planning adjustments, where appropriate.

Income & Capital Gains Tax Proposals

With the swearing-in of a new President and Vice President, plus convening of the next Congress, affluent Americans are weighing how changes in federal government may financially impact them.

Given that Democrats hold the Presidency and control both Houses of Congress by a slim margin, it now seems likely that tax reform could be passed as a budget reconciliation bill and then signed into law. While there is a remote chance that expected tax changes will be retroactive, it is more probable that they would take effect immediately upon becoming law or even at the start of 2022.

Since 2021 may be a last opportunity to capitalize on current income, capital gains, and transfer tax laws, families are considering key financial & estate planning adjustments, where appropriate.

“Be fearful when others are greedy and greedy when others are fearful.”

Responsive Planning

Given the above proposals, there is great uncertainty surrounding future tax policy. Even if some of the more benign tax provisions now in effect are not repealed, many of them are scheduled to sunset at the end of 2025 already.

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  • Phase out the 20% pass-through deduction on qualified business income for people with annual income exceeding $400,000
  • Eliminate capital gain deferral through like-kind exchanges of business & investment real estate for people whose yearly income exceeds $400,000
  • Increase the highest corporate income tax rate from 21% to 28% and subject corporate book income of $100,000,000 or more to a 15% alternative minimum tax
  • Double the tax rate on global intangible low tax income (GILTI) earned by foreign subsidiaries of American businesses from 10.5% to 21%
  • Impose a 10% surtax for U.S. companies that move manufacturing & service jobs to another country and then provide services or products for sale back to the American market
  • Create an advanceable 10% “Made in America” credit for manufacturers’ revitalizing, re-tooling and hiring costs
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