The Economy Continues to Look Good

The Economy Continues to Look Good

July saw a continuation of the global stock market recovery that began last October. Both U.S. and developed international stock markets increased by about 3%. Global small-cap stocks and emerging market equities, which had previously been weaker performers, delivered even better returns of 5% to 6%. The Fed increased their policy rate by an additional 0.25% during their July 26th meeting, boosting the yield on short-term bonds. That interest rate increase kept the overall U.S. bond market flat for the month.

With inflation taming, why did the Federal Reserve increase interest rates again? Part of that answer can be found in the strength of the U.S. economy. A report from the U.S. Bureau of Economic Analysis showed the domestic economy grew at an inflation-adjusted pace of 2.4% during the second quarter of 2023. Consumer spending remains healthy, and unemployment sits near record lows. The most economically sensitive industries saw the strongest stock price gains. Energy, for example, was the top performing sector in the S&P 500 in July, with financials, industrials and materials also beating most other sectors.

While it’s nice that the clamor of doomsday prognosticators has softened for the moment, it’s important to maintain perspective. U.S. company earnings are predicted to decline later this year. The low interest rates that justified higher stock valuations are not so low anymore. Stock market rallies often push stocks beyond their corporate earnings, as is the case with this rally. During a rally, it can be tempting to abandon bonds to chase media-celebrated stock returns. We caution against this. As mentioned in our most recent webinar, stocks are almost always projected to produce better returns than bonds, but the expected return gap has narrowed. Bonds continue to look attractive in this higher interest rate environment which creates some interesting opportunities.

Accordingly, we are in the midst of adjusting our bond allocations, with plans to extend the duration of some of our fixed income positions. Prior to the pandemic, we shifted our fixed income positions to favor short- and intermediate-term government bonds. That served our clients well. Short-term bonds will remain an important part of our allocation, but we also want to purchase long-term bonds to secure what we think are favorable rates that will be there for our clients if short-term rates eventually drop.

As we make our way into August, we wish all students a healthy and happy beginning to the academic year. If there is anything our team can help you with, please do not hesitate to let us know.

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