September Market Commentary

An August Setback with a Silver Lining

Equity markets corrected in August but a rebound in Energy Sector stocks softened the blow. Corporate earnings are expected to rise in the third quarter, following three consecutive quarters of declines. The Fed stuck to its script in Jackson Hole in late August, prepping investors for possible additional rate hikes. Equity markets are somewhat pricey entering September, but the upward trend of earnings estimates may support additional gains through the end of the year.

Equity markets declined across the board in August, with the S&P 500 Index and the NASDAQ Composite Index posting their first monthly declines since February. Emerging Markets declined 6.1%, a remarkable reversal from July's 6.3% positive gain. The bond market continued its downward trend, with the U.S. Aggregate Bond Index posting a fourth consecutive monthly decline.

A Re-energized Energy Sector

The S&P 500 Energy Sector Index (Energy Sector) was a standout performer in 2021 and 2022, producing a 60% annualized return. For context, the second-best performing sector was Healthcare with an 11% annualized return, while the S&P 500 Index gained a meager 2% per year. The robust relative performance was a welcome change for Energy Sector investors. For the 10-year period ending 12/31/2020, the Energy Sector LOST 2.7% per year. Through the first five months of this year, the Energy Sector appeared to be reverting to its old ways. Through May, the Energy Sector was down 11%. But since then, the Energy Sector surged.

The likely catalyst behind the recent surge is rising oil prices, up 23% since May. OPEC+ countries, responsible for 60% of the world's oil production, have been cutting production since October of last year. Demand was expected to decline this year, as many economists forecasted a recession. But over the last few months, pessimism has waned and a forecast of global oil demand hitting a new high emerged. With a shift in sentiment from oversupply to undersupply, energy stocks rallied. The four largest stocks in the Energy Sector Index, Exxon, Chevron, Schlumberger, and ConocoPhillips, are up 10%, 8%, 38%, and 21% respectively, over the last three months. The revival is surprising, given that the top oil production companies are expected to report at least a 30% year-over-year decline in earnings. If demand is higher than forecasted and supply is unchanged, earnings estimates may prove to be too low. While improving fundamentals are favorable for investors, risk cannot be overlooked. Stock price returns, noted above, have proven to be very volatile.

Corporate Earnings Set to Rebound

According to FACTSET research, the S&P 500 recorded its third consecutive quarter of declining earnings in Q2 2023, with a 4.1% year-over-year drop.i However, the tide seems to be turning. Interestingly, FACTSET noted that eight of the eleven sectors reported year-over-year earnings growth, with just Energy, Materials and Healthcare reporting declines. Now, for the first time in two years, analysts are raising estimates over the first two months of a quarter. Compare that to the past ten years, when the average decline in the earnings estimates during the first two months has been 3%. In addition, analysts have been raising estimates for the fourth quarter.

Profit resiliency and fading recession fears probably are boosting analysts' confidence. As was the case in 2020, corporate profit margins proved sticky when tested by an economic slowdown. Furthermore, a review of conference call transcripts by FACTSET indicated that companies cited "recession" 62 times during the second quarter. As the chart indicates below, the mention of "recession" on conference calls has dropped for four consecutive quarters.

The Federal Reserve (the Fed)

Federal Reserve Chairman Jay Powell spoke at an economic symposium on August 25th in Jackson Hole

Wyoming. Powell's speech, "Inflation: Progress and the Path Ahead," can be found here. ii

Powell said, "it is the Fed's job to bring inflation down to our 2% goal, and we will do so." The hawkish tone served as a reminder to investors that, while significant progress has been made to lower inflation, work remains. Powell's speech referenced the PCE (personal consumption expenditures), the Fed's go-to inflation measurement tool. The PCE peaked at 7% in June of 2022 and declined to 3.3% as of July. Reflecting on the progress, Powell said, "Given how far we have come, at upcoming meetings we are in a position to proceed carefully as we assess the incoming data and the evolving outlook and risks." In recent months, some economists questioned whether the Fed would move off its 2% inflation target, declaring the target unrealistic. Powell was clear, 2% remains the target.

Although we can't predict the path of interest rates, we believe two matters are near certain. Data will continue to drive monetary policy changes and the vigorous debate over whether the Fed will raise rates again will persist. The shift in sentiment from "higher for longer" to "high for longer", may be subtle, but captures the current state of affairs. The probability of additional rate hikes is falling, but so has the probability of near-term rate cuts. Powell noted that the full effects of past rate rises had not yet materialized and probably meant

"significant further drag in the pipeline." Stay tuned.

Looking Ahead

The Stock Trader's Almanac nailed it last month, calling for a tough August for stock investors, given the seasonality effect experienced over the past 25 years. August is the second worst performing month for the S&P 500 Index since 1988. The worst? September. We view any material setbacks as opportunities to acquire attractively priced assets. The S&P 500 Index is trading at about a 10% premium to its median valuation over the past seven years. We don't see the market as overly restrictive at current prices, but recognize some segments look very expensive, like the Technology, Materials, and Communication Services sectors.

The real yield on 10-year Treasury Notes (the nominal rate less inflation) has risen sharply to above 2%, from 1.5% in mid-July and 1% earlier in the year. The move higher is great for savers, providing inflation protection, a scarce commodity during part of the pandemic. 2023 has been challenging for bond investors, but if rates are "high for longer," total returns will improve.

We appreciate your confidence and support and hope you reach out to an Old Point Wealth Management team member with any questions.

i www.factset.com

ii https://www.federalreserve.gov/newsevents/speech/powell20230825a.htm

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