Thrivent Asset Management Contributors to this report: Steve Lowe, CFA, Chief Investment Strategist; John Groton, Jr., CFA, Director of Administration and Materials & Energy Research; Matthew Finn, CFA, Head of Equity Mutual Funds; and Jeff Branstad, CFA, Model Portfolio Manager

Stocks sold off in August as still robust growth, sticky inflation, and higher bond yields gave investors pause. The S&P 500 Index fell 1.77% during the month, with 10 of its 11 sectors generating a negative return.

A greater than expected 187,000 new jobs were added in August while retail sales rose 0.7%—nearly double consensus expectations—and corporate profits rose 4.5% in the second quarter, according to the Bureau of Economic Analysis’ August 30 report. As such, it was not surprising to see some second-guessing of the more bearish scenarios, with firms like Goldman Sachs cutting its odds of the U.S. economy entering a recession to just 15%.

Unfortunately, inflation increased slightly, with the headline Consumer Price Index (CPI) rising 3.2% in July. While the rise was largely driven by housing costs—shelter inflation contributed 90% of the index’s rise in July—it didn’t help that oil prices rose after Saudi Arabia and Russia extended their voluntary production cuts. Core CPI (which doesn’t include the more volatile food and energy sectors) fell 0.1% in July, to 4.7% year-on-year.  Also, the Federal Reserve’s (Fed) favored inflation measure, the core Personal Consumption Expenditures Price Index, ticked up to 4.2% year over year, which is well above the Fed’s target rate.

Fed Chairman Jerome Powell was clear in his remarks at the annual Jackson Hole symposium when he said, “Two percent is and will remain our inflation target.” While most investors feel the Fed’s policy rates are near their cyclical peak, Powell added that they “intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.” For investors hoping for a swift decline in interest rates to boost economic growth and corporate profits, this was probable cause for some profit-taking, or a lightening of investment risk.

Outlook: The U.S. economy has remained resilient, fueled by strength in the labor market and solid consumer spending. This has provided support to the equity markets, though the S&P 500 index’s performance has been dominated by select names within Information Technology and related sectors.

As such, investors are increasingly expecting that a U.S. recession is more likely to happen next year than in the second half of this year. While debate continues on the likelihood and severity of a recession, we believe we are beginning to see the signs of a slowdown. Employment data has weakened, with payrolls slowing, and the consumer is starting to show some signs of stress, with credit card delinquencies rising significantly.

In our view, the impact of the Fed’s swift interest rate rises is starting to show. We expect it will eventually lead to a noticeable slowdown in the economy, but whether it meets the definition of a technical recession (two consecutive quarters of contraction) is unclear, and the latest economic data suggests it may be slightly less likely.

However, the markets are expecting four cuts of 0.25% to the Fed’s policy rate next year as of this article’s publication, which we think is aggressive. We take Chairman Powell at his word that “two percent is and will remain” their inflation target and believe that will take time. Core inflation is simply too high to expect confirmation that it is moving “sustainably down toward” their objective anytime soon.

Nevertheless, we do believe we are at or near the peak in longer-term interest rates, and as short-term rates fall next year, we expect the U.S. Treasury curve will steepen. As such, both short and intermediate government bonds, with current yields near 5%-5.5%, continue to look compelling. Longer-dated U.S. Treasury bonds also deserve a closer look as they historically perform well as the economy slows significantly or turns into a recession.

But turning points in the U.S. economy are notoriously difficult to time. And today’s more globalized economy adds additional complications as geopolitical wild cards abound. Might we see a post-Putin Russia in the second half of 2023? How, and when, will the tensions between China and Taiwan be resolved? How convoluted and disruptive might the 2024 U.S. Presidential election become in the coming quarters? In this uncertain environment, we encourage equity investors to stay focused on the longer-term trends and—absent clarity—wait patiently for clearer signs of the economy’s direction.

Drilling down

U.S. stocks slip

The S&P 500^® Index fell 1.77% in August, from 4,588.96 at the July close to 4,507.66 at the end of August. The total return of the S&P 500 Index (including dividends) for the month was -1.59% and 18.73% year to date. (The S&P 500 is a market-cap-weighted index that represents the average performance of a group of 500 U.S. large capitalization stocks.)

The NASDAQ Index also fell in August (down 2.17%) from 14,346.02 at the end of July to 14,034.97 at the August close. For the year, the NASDAQ was up 34.09% through August, as technology stocks rebounded off their large losses in 2022. (The NASDAQ—National Association of Securities Dealers Automated Quotations—is an electronic stock exchange with more than 3,300 company listings.)
 

Retail sales continue to rise

Retail sales were up 0.7% from the previous month in July, and up 3.2% from 12 months earlier, according to the Department of Commerce retail report issued August 15. Rising sales were again led higher in the month by non-store retailers (primarily online sales) and food services & drinking places, rising 1.9% and 1.4% respectively, as consumer spending remains robust.

The gains were more impressive on a year-on-year basis, with non-store retailers up 10.3% from July of last year. Consumers also remained more active in restaurants and bars compared to a year ago, with food and drinking establishment spending up 11.9% year-on-year.

While sales at gasoline stations rose on the month (up 0.4%), year-on-year sales collapsed, with sales down 20.8% from last July due to higher average gasoline prices last summer.

Furniture & home furnishing stores weighed the most on the index in July, down 1.8% over the month, followed by electronics & appliance stores, down 1.3%.

Job growth slowing

The U.S. economy added 187,000 new nonfarm jobs in August, according to the Department of Labor’s (DOL) September 1 report, well below the 271,000 average number of new jobs the economy gained over the last year. Once again, health care added the most employees, at 71,000, followed by strong gains in leisure and hospitality (40,000) and social assistance (26,000). Transportation employment fell by 37,000 jobs, largely due to the bankruptcy of trucking giant Yellow Corp.

The unemployment rate rose from 3.5% to 3.8%, the highest level in over a year, but the labor force participation rate also rose (by 0.2%) after being relatively unchanged since March, and the figures may be influenced by the bankruptcy of Yellow Corp.

The number of part-time employees, at 4.2 million, was up from 4.0 million in July, while average hourly earnings for all employees rose 0.2% (8 cents) to $33.82 in August, a 4.3% rise from a year ago.

All sectors but Energy fell in August

The S&P 500 Index saw broad-based weakness in August, with 10 of the 11 sectors generating a negative return. Utilities led the market lower, falling 6.16% on the month, followed by Consumer Staples and Materials, falling 3.57% and 3.28%, respectively. Energy was the sole positive sector for the month, rising 1.81% in August and bringing its year-to-date return to 3.31%. Even the Information Technology and Consumer Discretionary sectors—the strongest sectors year-to-date—declined, with Information Technology falling 1.32% and Consumer Discretionary falling 1.17% over the month, lowering their respective year-to-date returns to 44.66% and 34.72%.

The chart below shows the past month and year-to-date performance results of the 11 sectors:

Treasury yields push above 4.0%

The yield on 10-year U.S. Treasuries rose from 3.95% at the end of July to break 4% again, closing August at 4.09%. A combination of factors pushed rates higher, including sustained economic growth, greater Treasury bond issuance to fund the deficit, rising oil prices, and concerns real rates (the yield a bond pays after subtracting inflation) may stay higher for longer.

The Bloomberg U.S. Aggregate Bond Index was down 0.93% in August. (The Bloomberg U.S. Aggregate Bond Index is an unmanaged index considered representative of the U.S. investment-grade, fixed-rate bond market).

Oil prices rise

Oil prices rose in August, as sustained demand coupled with declining supply from oil producing countries pushed prices higher. A barrel of West Texas Intermediate, a grade of crude oil used as a benchmark in oil pricing, rose 2.24% over the month, from $81.80 at the end of July to $83.63 at the August close. Higher prices were in part due to Saudi Arabia and Russian extending their voluntary supply cuts.

Gasoline prices at the pump pushed closer to $4 in August, with the average price per gallon rising from $3.71 at the end of July to $3.98 at the end of August.

International equities drop

International equities dropped in August as weak economic growth and high energy costs fueled concerns the central bank may have to keep interest rates high, despite slowing economic growth. The MSCI EAFE Index fell 4.10% for the month, from 2,199.36 at the end of July to 2,109.16 at the August close. The index, which tracks developed-economy stocks in Europe, Asia, and Australia, reduced its year-to-date gains to 8.50% as of the August close.