Weekly Investment Update (09/29/2023)

This Week’s Views and Positioning

Both stocks and bonds posted losses in September, with 10-year yields approximately 40 basis points higher and equities about 4.5% lower. Inflation continues to decline, and the driver of higher interest rates in the month has been continued strong growth and accompanying Fed commentary suggesting a bias to hold interest rates higher for longer. Growth is likely to reach a whopping 5% in the third quarter, but signs are increasing, in our view, that activity will moderate. In this week’s note, we discuss a likely government shutdown and developments in the housing market, both of which are suppressants of growth optimism.

In our view, the Fed continues to talk tough to contain financial conditions or tighten them at the margin. It is likely on hold with rates at current levels with the goal of deterring the market from pricing in too much easing in 2024. The memory of the Fed’s mischaracterization of inflation being “transitory” in 2021 and early 2022 is fresh, and for the time being it wants to err on the side of sounding hawkish. That said, when the Fed eases, it rarely telegraphs its intentions in advance — easing has historically happened abruptly and is often significant. With inflation more contained, growth declines could drive this shift quickly next year. This helps inform our view of holding bonds over cash and extending the average maturity in bond portfolios to lock in higher rates for longer. As for equities, we have tilted away from highly cyclical sectors in favor of companies that can continue to compound in a slower growth environment.

Next week, we will publish our Quarterly Investment Perspective, which will include a more thorough discussion of the macroeconomic environment as well as firsthand takeaways on short- and long-term developments in China.

Risk of Government Shutdown Rises

What is happening: A government shutdown appears increasingly likely to commence on October 1 given Congress’s inability to agree on spending for the upcoming fiscal year. Politicians have been challenged to reach a bipartisan vote required to avoid a shutdown given disagreements between the two parties and, in some cases, within the individual parties, primarily related to additional funding for Ukraine and border security. In a shutdown, essential government employees continue working while other federal employees are furloughed; whether working or furloughed, all government employees would not receive a paycheck until Congress passes additional funding. We do not rule out the possibility of a short-term extension, but this would also require bipartisan support.

Why it matters: The average duration of previous government shutdowns since 1976 is eight days, though the length has varied. While historically S&P 500 performance and government shutdowns have not shown a meaningful correlation, should a shutdown commence, in conjunction with building headwinds, such as strikes, resumption of student loan payments, and the backdrop of higher interest rates, market volatility could increase. If the government is shut down, economic data releases would be delayed, and future data collection paused. These developments have important market implications as the Federal Reserve would be left without up-to-date data in a prolonged shutdown scenario (roughly longer than two weeks). Historically, government shutdowns have not caused outsized negative impacts to growth, as much is recovered when the government opens. Still, the ultimate impact is largely dependent upon the length of the shutdown.

High Mortgage Rates Continue to Pressure New Home Sales

What is happening: An annualized total of (seasonally adjusted) 675,000 newly constructed single-family homes were sold in August — a fall of 8.7% from July sales and above expectations of a 2.2% decline. The total, which is based on contract signings, was the slowest pace of monthly sales since March.

Why it matters: The August home sales data is the latest sign that the new construction side of the housing market, which had been more resilient than the overall housing market, is starting to weaken. Homebuilders, eager to sell their inventory of homes, have offered incentives such as below market-rate mortgages to potential purchasers in order to encourage home sales. However, these incentives are starting to lose their attractiveness as mortgage rates continue to climb on the back of rising bond yields. The average rate on a 30-year fixed rate mortgage is currently 7.8%, up from 6.7% at the beginning of the year and five percentage points higher than the low of 2.8% seen in February 2021.

The median price of a newly built home sold in August was $430,000, a drop of 2% compared with August of last year. The fall in prices commences as inventory continues to be in short supply. Supply shortages had allowed the prices of homes to remain elevated but there are now signs that the multi-decade high mortgage rates are outpacing the supply shortages. Housing inventory measured by the National Association of Realtors at the end of August was about 14% lower than a year earlier. Bessemer portfolios are underweight the homebuilding sector as elevated rates continue to pressure the sector — a dynamic we expect to continue into next year.