Monthly Market Update – August 2023

Key Points

• Stocks Take a Breather August lived up to its reputation as a difficult month, with most major indices posting monthly declines. But although August’s declines were broad-based, they were relatively shallow. The S&P 500 Index fell -1.6% in August (total return) for just its second down month of the year and first negative month since February. Small caps lagged again (they have underperformed large caps in five of the last six months), dropping -5%. Developed international and emerging markets equities fell about -4% and -6%, respectively. 
• Value To Growth Near COVID Lows The Russell 1000 Growth Index has outperformed the Russell 1000 Value Index in 6 of the 8 months in 2023, putting the Growth index +26 percentage points higher than the Russell Value index so far in 2023. That only trails 2020 when Growth outperformed by more than +35 percentage points. 
• China Loses Top Spot Deepening tensions between the U.S. and China are eroding trade ties between the world’s two largest economies. Importers are increasingly turning to Mexico, Europe, and other parts of Asia for goods in place of China. As a result, for the first time since 2008, China is no longer the largest source of global imports in the U.S.
• Synchronized Central Bank Tightening Most developed country central banks have broken a 15-year streak of keeping rates at or near zero with an unprecedented, synchronized rate hiking cycle that the world has never seen. Markets shouldn’t expect the lockstep policy to continue as the world’s economies begin to diverge, particularly China and the eurozone, which are experiencing dramatically slower economic activity.
• The September Effect The worst month of the year for U.S. equities is here, but some positive market signals suggest it may not be so bad this time around. While seasonal trends place September in last place for stock market performance, returns have been most robust in times the S&P 500 gained between +10% and +20% year-to-date through August, like 2023, according to Bank of America research.

Market Summary

Asset Class Total Returns

Source: Bloomberg, as of August 31, 2023. Performance figures are index total returns: US Bonds (Barclays US Aggregate Bond TR), US High Yield (Barclays US HY 2% Issuer-Capped TR), International Bonds (Barclays Global Aggregate ex USD TR), Large Caps (S&P 500 TR), Small Caps (Russell 2000 TR), Developed Markets (MSCI EAFE NR USD), Emerging Markets (MSCI EM NR USD), Real Estate (FTSE NAREIT All Equity REITS TR).

August has a reputation as being something of a tough month for stocks because of lower trading volumes from traders and investors being on holiday, the August recess for Congress, and seasonal profit taking ahead of the traditional dog days of September. This year was no exception, as most major indices posted monthly declines. But although August’s declines were broad-based, they were relatively shallow. Following a stellar +21% return for the S&P 500 Index in the first seven months of 2023, the index fell -1.6% in August (total returns with dividends reinvested). It was just the second down month of the year for the benchmark U.S. index and the first negative month since February. All things considered, that is not such a terrible outcome, especially given the index was down nearly -5% on August 18 before rallying +3.3% through the end of the month. It was only slightly worse for the Nasdaq Composite Index as technology stocks, which makes up nearly 50% of the index, struggled for much of the month. The Nasdaq finished down -2.2%, its worst month since December, and like the S&P, its first negative month since February. But also like the S&P, it was looking much worse mid-month when it was down more than -7% (on August 18), before rebounding into the close of the month. Small cap stocks suffered the most damage in August, with the Russell 2000 Index dropping -5% for the month. Like the S&P and Nasdaq, the Russell was down the most in the middle of the month (-7.5% on August 17), but unlike the other two larger capitalization indexes, it didn’t see much of a rebound into the end of the month. And in contrast to the S&P and Nasdaq, the Russell has only had three positive months in 2023.

The month got underway with the credit rating agency Fitch downgrading the U.S. government’s credit rating from AAA to AA+, citing unsustainable debt and deficit trajectories and what it described as a “steady deterioration in standards of governance” over the past two decades. Ultimately, the downgrade had little impact on 10-year U.S. Treasury yields, which barely rose upon the announcement. However, the yield on the 10-year did rise as the month progressed on stronger-than-expected economic data and uncertainty surrounding the path of China’s economy, peaking at 4.34% on August 21 – its highest level since 2007. The minutes of the Federal Reserve’s July rate decision meeting revealed that most officials remain concerned about inflation and thus left the door open for additional rate hikes if necessary. But then yields began to retreat into the final week of August as inflation data moderated and jobs data came in softer than expected. On the inflation front, headline Consumer Price Index (CPI) increased slightly in July to a 3.2% annual rate, primarily due to higher food and energy prices, while Core CPI decelerated slightly to a 4.7% annual rate from 4.8% in June. The labor market showed signs of cooling but remained strong, with 187,000 nonfarm payrolls added in August, slightly below expectations, and July and June were revised materially lower. The unemployment rate jumped to 3.8% from 3.5%, the highest level in 18 months.

Additionally, the second estimate (of three) for second-quarter Gross Domestic Product (GDP) for the U.S. economy was released in the final week of the month and was unexpectedly revised lower to +2.1% from the original +2.4% rate of growth. But the late month retreat in yields wasn’t enough to save bonds from yet another down month. The Bloomberg Aggregate U.S. Bond Index dipped -0.6% in August, marking its fourth straight negative week tying for the second-longest monthly losing streak since 1994.

The situation overseas was worse than in the U.S., with Developed Market international stocks (MSCI EAFE Index) falling -4.1% in August and Emerging Market stocks (MSCI Emerging Markets Index) dropping -6.4%. We mentioned last month that China and the Eurozone would likely face pressures from material economic slowdowns, and that was essentially what transpired in August. In China, economic activity data was much weaker than expected, with their CPI turning negative, retail sales missing expectations by a wide margin, and poor business confidence resulting from a particularly suspect real estate sector. The Shanghai Composite logged its worst monthly performance since September 2022, dropping -5.1%, while Hong Kong’s Hang Seng Index fell -8.2, putting it into a bear market. In Europe, the flash GDP estimate showed that the euro area only grew by +0.3% quarter-over-quarter in the second quarter. The August Purchasing Manager’s Index (PMI) fell to 47, the lowest level since 2012. International bonds (the Bloomberg Aggregate Global Bond Index ex U.S.) also struggled, dropping -2.0% in August, as rising yields and a rising U.S. dollar (up +1.7% in August) were major headwinds.

Despite a downbeat August, virtually all major asset classes are still boasting decent year-to-date (YTD) gains. The S&P 500 and Nasdaq lead global markets with YTD returns of +18.7% and +34.9%, respectively. Most economists and market strategists are calling for a soft landing as recession risks fade. However, corporate earnings are in a recession, as the S&P 500 posted its third straight quarter of negative earnings growth for the just-completed second-quarter earnings season. We reiterate that if the Fed is indeed nearing the end of their rate hiking campaign, and the contraction in corporate earnings troughs, and credit conditions don’t tighten much further, then a brief and shallow downturn may be the worst scenario in 2023, with the beginning of new business cycle possibly taking hold in 2024. 

Source: Bloomberg, as of August 31, 2023.
Price Returns for Equity, Total Returns for Bonds.
* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Quick Takes

EVEN THE ‘MAGNIFICENT 7’ TOOK A PAUSE

Last month, we featured how equity markets were having one of the best starts to the year in history but that the performance was essentially concentrated in just seven stocks. The S&P 500 Index was up +20.6% in 2023 through July, but the so-called “Magnificent Seven”—Tesla, Apple, Nvidia, Microsoft, Amazon, Meta, and Alphabet—collectively soared more than +65% through July while the remaining 493 stocks in the index were up less than +8% (meaning those seven stocks accounted for nearly 70% of the S&P 500’s gains in 2023). So, it shouldn’t surprise anybody that in a month like August, that saw virtually all segments of the market decline, that the Magnificent Seven also took a breather. Going into the third week of August, all Magnificent Seven stocks were down-five of them down more than the S&P 500. But the easing labor market data and softer-than-expected economic data late in the month fueled a solid recovery for the ‘gang of seven.’ Three members finished August with gains, and even Tesla, which was down nearly -20% in the middle of the month, was able to rally to only a modest -3.5% decline at the end of August.

S&P 500 & Magnificent 7 Year to Date Gains

Year-to-Date to 7/31/2023 versus August 2023

Source: Bloomberg.

VALUE TO GROWTH RELATIONSHIPS APPROACH COVID LEVELS

In no small part due to the Magnificent Seven, growth-oriented stocks are nearing record outperformance over value-oriented stocks. The Russell 1000 Growth Index has outperformed the Russell 1000 Value Index in 6 of the 8 months in 2023, putting 2023 on pace to be the second-largest year of outperformance since the index series began in 1979. Through August, the total return of the Russell Growth index is +26 percentage points higher than the Russell Value index. That only trails the 2020 calendar year, which saw Growth outperform by more than +35 percentage points. The next closest year was 1999, when Growth had a nearly +26 percentage point advantage. Looking at the chart below, it sure appears that Value is destined to sink to the extreme disparity relative to Growth that occurred in September 2020 and again in November 2021. No surprise that the Growth index has substantially more weight in the top three performing sectors in 2023: Technology, Communication Services, and Consumer Discretionary. Vanguard points out that if the Federal Reserve can engineer a soft landing—sidestepping a recession with the economy’s next move being an acceleration—the case for Value is strengthened. According to their research Value, on average, has outperformed Growth during economic recoveries. 

Disparity Between Value and Growth Nears Covid Extremes

Source: Bloomberg. Data as of 8/31/2023.

BESPOKE’S MORTGAS INDEX: THE NEW MISERY INDEX?

Economist Arthur Okun created the Misery Index in the 1970s to measure economic distress by average Americans. It is calculated by adding the U.S. inflation rate and the U.S. unemployment rate. The 1970s were dominated by stagflation, or the simultaneous occurrence of high inflation and high unemployment. A few weeks ago, investment research firm Bespoke Investment Group introduced their MORTGAS Index. Like the Misery Index, it is a simple way to express economic distress by adding the 30-year average national fixed mortgage rate and the average national price for a gallon of gas. High mortgage rates and high gas prices are a pain point for the average U.S. consumer, and in August, the Bespoke MORTGAS index continued to sit at multi-decade highs.

The Bespoke MORTGAS Index

Mortgage Rates + Gas Prices (Last 20 Years)

*Bankrate.com 30-Year National Average Fixed Rate Mortgage, AAA National Average $/Gallon Regular Unleaded.
Source: Bespoke Investment Group.

BREAKING UP IS HARD TO DO

Deepening tensions between the U.S. and China are eroding trade ties between the world’s two largest economies, with goods from China accounting for the smallest percentage of U.S. imports in 20 years. Instead, buyers are turning to Mexico, Europe, and other parts of Asia for goods ranging from computer chips and smartphones to clothing, according to data released in August by the Census Bureau. J.P. Morgan notes that “nearshoring” (moving offshore manufacturing closer to the U.S.) and “friendshoring” (moving offshore manufacturing to places that have strong diplomatic relations with the U.S.) has accelerated in the last year, continuing a trend in place for several years, but is just now marking the first time since 2008 that China is no longer the U.S.’s largest source of global imports.

China is No Longer the U.S.’s Largest Source of Imports

Source: FactSet, U.S. Census Bureau, J.P. Morgan Asset Management.

WILL SYNCHRONIZED TIGHTENING BE A NEW OLYMPIC SPORT?

Of course, that title was typed tongue-in-cheek, but one must be impressed by how tight and cohesive the rate hiking has been over the last two years by the world’s preeminent central banks. As FS Investments notes, most developed country central banks have broken a 15-year streak of keeping rates at or near zero with an unprecedented, synchronized rate hiking cycle that the world has never seen. Looking at the right-hand side of the chart below, it is difficult to tell one central bank from another in the dramatic spike higher in policy rates since 2022. Looking ahead, markets shouldn’t expect the lockstep policy to continue. The world’s economies are beginning to diverge; in particular, China and the eurozone are seeing dramatically slower economic activity, which will likely push policy makers on divergent policy paths in 2024.

Simultaneous Global Tightening on An Unprecedented Scale

Source: Federal Reserve, Bank of Japan, European Central Bank, Bank of Canada, Bank of England, Reserve Bank of Australia, FS investments. Data as of July 28, 2023.

STOCKS HAVE HAD A GREAT YEAR… CUE THE SEPTEMBER EFFECT

September has a lot going for it. Temperatures are cooling, kids are back in school, football season starts, and the leaves on the trees become more colorful. But for investors, September is one of the least desired months. The month is historically the weakest month for stocks, both in terms of lowest average returns and lowest frequency of gains. As shown in the tables below, according to Dow Jones Market Data, the S&P 500 has lost an average of -1.1% in September, dating back to 1928, one of only three months that have averaged losses and easily the worst of the three. The worst September was in 1974, when the benchmark plunged nearly -12%. In 1946 and 2002, it also recorded double-digit selloffs. In fact, the last three years have seen negative Septembers, but that actually may provide some hope for this year. The last time the S&P 500 had a three-September losing streak—from 2014 through 2016—it followed with a three-year winning streak. Plus, when the S&P 500 was up between +10% and +20% through August, like it is this year, it has averaged a gain of +7.6% for the rest of the year, according to Bank of America data.

September is Historically the Worst Month for Stocks

Source: Federal Reserve via St. Louis Fed, The Wall Street Journal.

Asset Class Performance

The Importance of Diversification. Diversification mitigates the risk of relying on any single investment. It offers many long-term benefits, such as lowering portfolio volatility, improving risk-adjusted returns, and helping investments to compound more effectively.

Source: Bloomberg.
Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by The Retirement Planning Group. The performance of those funds may be substantially different from the performance of the broad asset classes and to proxy ETFs represented here. US Bonds (iShares Core US Aggregate Bond ETF); High‐Yield Bond (iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares US Real Estate ETF). The return displayed as “Allocation” is a weighted average of the ETF proxies shown as represented by: 30% US Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4% Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.

* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Chris Bouffard is CIO of The Retirement Planning Group (TRPG), a Registered Investment Adviser. He has oversight of investments for the advisory services offered through TRPG.

Disclaimer: Information provided is for educational purposes only and does not constitute investment, legal or tax advice. All examples are hypothetical and for illustrative purposes only. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. Please contact TRPG for more complete information based on your personal circumstances and to obtain personal individual investment advice.