Our Current Market and Economic Outlook

September 30, 2023

A Government Shutdown

You are probably seeing a lot of talk in the news about the problems facing the market.  One of those problems is the government shutdown.  Our view is that, like debt ceiling debates, all shutdowns are temporary setbacks to the market.  The government will not shut down permanently, if it shuts down at all.  When it opens the market will rebound and most of the lost payments and payroll that the government didn’t make earlier will be made.  Thus, there is no significant long-term effect on the economy or stock market.

UPDATE:  Congress postponed government shutdown for 45 days.

  Economic Growth 

As for the economy, according to Blue Chip Economic Indicators, a survey of business economists, the US is heading for 3% growth this year.  Even if it is less, economic growth is fine. The US typically sees about 2.5% growth.  We basically agree with the Blue Chip forecast.

The Stock Market

As for stocks, FactSet, a company that surveys stock analysts, says its most recent survey on September 21, shows analysts are expecting a 19% increase in the S&P 500 over the next 12 months.  We agree with the FactSet survey and think it might even be a little low.

Higher Interest Rates for Longer Will Kill Bonds

The Fed continues to sell bonds, thus destroying money instead of printing money.  That is raising rates on the 10 year bond which is the primary interest rate that moves stocks, bonds and real estate.   We said earlier that we thought we would have higher rates for longer and are increasingly seen as being correct.  We differ strongly from many market analysts who think the Fed will drop rates dramatically over the next year.  

Higher rates for longer are devastating to bonds.  In fact, the largest bond ETF is now as low as it was in 2011.  Compare that to stocks:  At the end of 2011, the S&P 500 was at 1350.  Now it is at 4273.  That’s nearly a 300% gain. So, bonds are not only getting crushed, but getting crushed especially compared to stocks.  

Higher Rates Hurting Stocks Now, but Not Long Term

Of course, higher rates are also negative for stocks.  However, the good news for stocks is that most of the rate increase we have seen since the Fed started hiking rates in early 2022 is over. The 10 year rate was 1.5% in January 2022 and is now 4.5%.  Yet, the market is still up 10% this year.  That shows stocks can easily adjust to higher rates, unlike bonds. Even if the 10 year rate goes up a little further to 5%, which is about as high as we think the Fed will take it, that means almost all the increase in the 10 year rate is over.  

Once rates stabilize, stocks will resume their upward path.  However, bonds will not. They need LOWER interest rates to make significant gains.  Please see my earlier article on bonds on September 20th for the reasons why.

Unlikely the Fed Will Let 10 Year Interest Rates Rise Much Over 5% for Any Length of Time

As for why we think the Fed won’t let the 10 year rate go over 5%, it’s because the Fed won’t want to crush the bond market too much more.  They need bond buyers lest they be the only buyer of bonds in the market.  That would be very bad for the Fed because it would force them to print an enormous amount of money.  Better to just keep interest rates from going too high than cause a bond crisis.

Economic Stimulus from Massive Government Borrowing Is Offsetting the Negative Impact of Higher Rates on the Economy

Won’t higher interest rates also hurt the economy?  Yes, we are already seeing a slowdown in auto sales and home sales because of high rates. That will mean slower growth next year.  Will it be enough to cause a big recession?  

In normal times, absolutely.  But we are not in normal times.  The Fed has doubled its very stimulative borrowing from $1 trillion last year to $2 trillion this year and will likely borrow even more over the coming years.  That stimulus, which is close to 10% of the economy, will support some economic growth, even though it is unlikely to be as much as this year.

NOTE:  Ignore Changes in the Fed’s Overnight Rate

I always try to make clear that the interest rate to watch is the 10 year government bond rate, NOT the overnight rate which the Fed changes (or doesn’t change) at its periodic meetings.  That rate is now 5.25%.  That’s higher than the 10-year rate of 4.5%, but the rate that matters to stocks, bonds and real estate is the 10 year rate because business borrowing/investment is long term and definitely not overnight.  Only banks borrow at the overnight rate.  So, only the 10 year government bond rate actually matters to the stock market. 

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