After a tough four-day losing streak, the S&P 500 now sits just a hair above the 2022 low. The index lost 4.7% on the week, bringing the total decline on the year to 22%. Markets are coming to grips with rising recession odds as the Fed stands firm in its fight against inflation. At the September meeting, Fed officials made clear their willingness to sacrifice economic growth and full employment to bring down inflation. With such an aggressive policy stance, the hurdles are getting taller for stocks.
Hopes for moderating inflation were dashed by another hotter-than-expected report for the month of August. Even with a sharp decline in prices at the gas pump, consumer prices overall increased .1% on a month-over-month basis. This may not seem like much, but digging further into the data reveals that inflation is alive and well within core goods and services. Excluding fuel and energy, inflation increased by .6% on a month-over-month basis in August. Sharply rising prices for services are of particular concern. Gains in this category are being fueled by what is known as a wage/price spiral. This occurs when an extraordinarily tight labor market leads to broad-based wage increases that are ultimately passed on to consumers in the form of higher prices. As consumers face a rising cost of living, they seek higher wages to compensate, and the cycle perpetuates.
To break the wage/price spiral, the Fed needs to drive up the unemployment rate. This can be done through layoffs or by increasing the size of the labor pool. Adding to the labor force is obviously preferable from an economic growth standpoint, but it is unlikely that there are enough workers on the sidelines to meaningfully drive unemployment higher. Thus, as the Fed continues to raise interest rates, some jobs are likely to be lost, and the economy is likely to contract. Because of this, stocks are starting to reprice for the possibility of lower earnings. To date, the weakness in the market has been caused by higher interest rates and not lower earnings estimates. However, we are now starting to see analysts adjusting their forecasts lower.
The economic backdrop is difficult, and we can’t be sure that stocks have put in a bottom. What we do know is that quality companies will survive and come out stronger on the other side, just as they have so many times in the past. In times of stress, we lean further into the power of rising dividends. Despite their stock prices, we believe the majority of our companies have the capacity to continue increasing their dividends through periods of economic stress. They have experienced management teams, strong balance sheets, consistent cash flows, and disciplined strategies necessary to maintain dividend growth through temporary economic disruptions. Rising dividends represent real growth in the fundamental value of a stock. If dividends are growing, market prices should follow in time.
Preston May, CBE®
This report was prepared by Donaldson Capital Management, LLC, a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Information in these materials are from sources Donaldson Capital Management, LLC deems reliable, however we do not attest to their accuracy.
An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance to certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Past performance is not a guarantee of future results. The mention of specific securities and sectors illustrates the application of our investment approach only and is not to be considered a recommendation by Donaldson Capital Management, LLC.
S&P 500: Standard & Poor’s (S&P) 500 Index. The S&P 500 Index is an unmanaged, capitalization-weighted index designed to measure the performance of the broad U.S. economy through changes in the aggregate market value of 500 stocks representing all major industries.