Weekly Market Update: October 9, 2023

Inflation is running at a level that is still too high for the Federal Reserve. The Personal Consumption Expenditures (PCE) Price Index, which is the measure of the U.S. inflation situation tracked most closely by the Federal Reserve, rose 0.4% and 3.5% on a month-to-month and one-year basis, respectively, in August. Those figures inched up from the July readings. On a positive note, the core-PCE Price Index, which excludes the food and energy components, eased during both periods.

Wall Street expects the central bank to keep the federal funds rate higher for a longer period. Price increases are still notably above the Fed’s target level of 2%, and with the job market continuing to hold up quite well, senior Fed officials may not be in a rush to reverse monetary course. Jobless claims are still running well below a level indicative of stress in the labor market.

The restrictive monetary policies are putting upward pressure on Treasury market yields and the value of the U.S. dollar versus a basket of international currencies. The resultant higher borrowing costs make it more difficult for companies to run their businesses and for families to manage their household budgets. This will probably put pressure on near-term economic expansion. From a stock market perspective, investors become more hesitant to bid up stock prices because the value of future earnings/cash flows look less attractive.

Third-quarter earnings season will be highly scrutinized. According to FactSet Research, the price-to-earnings ratio for S&P 500 companies, at 17.9, has come down following the recent equity market weakness, but the measure is still above the 10-year average of 17.5. Given this higher interest-rate backdrop, earnings will need to be solid if the current valuations are to be justified. Profits have declined in three consecutive periods for S&P 500 members and are forecasted to be flat, on average, for the third quarter. The earnings results and, maybe more so, company prognostications will also provide clues to how the economy is faring.

Conclusion: September lived up to its reputation as a difficult month for equities. Stock market valuations have eased a bit, but with many headwinds still in place, including inflation and restrictive monetary policies, this is not the right time to start throwing caution to the wind.

Source: ValueLine.com