The stock market moved higher in August in response to generally positive economic news, easing inflation, strong corporate earnings, and growing confidence that the Federal Reserve will begin lowering interest rates next month. The S&P 500 Index advanced 2.4%, bringing its year-to-date return to 19.5%. This left the index just slightly below its all-time closing high of 5,667 reached on July 16th. Most sectors of the market moved higher led by gains in consumer staples, real estate, and healthcare. Internationally, the developed and emerging markets appreciated 3.3% and 1.6%, respectively, bringing their year-to-date returns to 12.0% and 9.5%.

• Interest rates moved lower across the yield curve in August, lifting the major bond market indexes. The yield on 10-year U.S. Treasury notes declined by 0.13%, settling at 3.90% on August 30th. The yield on 2-year U.S. Treasury notes fell by 0.34% to 3.92%. The Bloomberg Aggregate Bond and the Bloomberg U.S. Municipal Bond Indexes rose 1.4% and 0.8%, respectively, bringing their year-to-date returns to 3.1% and 1.3%.
• In a highly anticipated speech at the Kansas City Fed’s Annual Jackson Hole Economic Policy Symposium on August 23rd, Federal Reserve Chairman Jerome Powell remarked that “the time has come for policy to adjust” referencing the federal funds target rate, currently set within a range of 5.25% - 5.50%. He expressed confidence that inflation is on a sustainable path back towards the central bank’s long-term target of 2%. He noted that the labor market “has cooled significantly from its formerly overheated state” and that “it seems unlikely that the labor market will be a source of elevated inflationary pressure any time soon”. He did not specifically mention the timing and magnitude of future fed funds rate cuts and indicated that the Fed’s decision will remain data dependent. However, forecasters are highly confident that the Fed will cut rates by 0.25% when the Federal Open Markert Committee (FOMC) meets on September 18th. As of August 30th, fed fund futures imply the FOMC will cut rates by nearly 1.0% by the end of the year.
• Inflation continued its downward trend through July. The Bureau of Labor Statistics reported the Consumer Price Index (CPI) declined to 2.9% from 3.0% in June. Core CPI – which excludes food and energy – slipped to 3.2% from 3.3%. The Federal Reserve’s preferred measure of inflation, the Personal Consumption Expenditure (PCE) Core Price Index, was 2.6% in July. This was slightly below the consensus forecast of 2.7% and unchanged from June. All inflation measures are calculated on a year-over-year basis.
• On August 29th, The Bureau of Economic Analysis revised its estimate of the U.S. economy’s growth during the second quarter to 3% from 2.8%. The adjustment was largely due to a significant upward revision to personal consumption.
• The overall economy appears to be faring well through the summer. S&P Global’s Flash U.S. Composite Purchasing Manager Index (PMI), which tracks the manufacturing and services sectors, held fairly steady at 54.1 in August compared to 54.3 in July. A slight pick-up in the services sector was offset by an easing in the manufacturing sector. Index levels above 50 are indicative of expansionary economic conditions.
• Initial claims for unemployment benefits eased to a weekly average of 230,00 during the first three weeks of August compared with 237,000 for the month of July. This helped to ease worries that emerged in late July that labor market conditions were rapidly deteriorating.
• Corporate earnings held up well in the second quarter with S&P 500 earnings per share gaining approximately 13% year-over year. Nearly 80% of S&P companies reporting their results exceeded analyst expectations.

Analysts estimate S&P 500 earnings per share will increase by about 10% this year and 15% next year. With the S&P’s return already approaching 20% just eight months into the year, much of this positive outlook appears to be already reflected in stock prices. Wall Steet strategists have a positive view on the fundamental underpinnings of the stock market, but their return expectations are quite modest reflecting valuation concerns. Strategists’ median forecast for the S&P 500 at year end is 5,600, slightly below its August closing price of 5,648.

• Although the stock market does appear expensive, trading at over 23 times projected 2024 earnings and with a cash dividend yield of under 1.3%, it could get more expensive. Towards the end of the 1990’s bull market, the S&P 500’s price-to-earnings ratio had climbed to nearly 30 times and its cash dividend yield fell to about 1%. Valuation concerns expressed as early as 1996 did little to stop the stock market’s rise. Stocks were soaring in the late 90’s fueled by excitement surrounding rapid advances and deployment of digital communications technologies including the internet. Today’s equivalent is the rollout of artificial intelligence. If the economy holds up, earnings continue to come through and inflation subsides, the stock market seems likely to power higher. However, sharp selloffs could be triggered by even minor disappointments given elevated valuation levels.
• This month, investor attention will be focused on the press conference and forecasts released following the FOMC’s two-day meeting which will conclude on September 18th. A fed funds target rate of 0.25% is already baked into stock and bond market pricing, and if it occurs, it is not likely to cause much of a reaction. There will be particular interest in the FOMC’s projections for inflation and the fed funds rate at the end of this year and 2025. There is likely to be disappointment if these projections are not lowered from the FOMC’s last Summary of Economic Projections released in June.
• Key data items to be released prior to the FOMC meeting include August’s non-farm payrolls, unemployment rate and wage growth. The reports will be released by the Bureau of Labor statistics on September 6th.
• The Bloomberg median forecast for non-farm payroll additions is 165,000, up from July’s disappointing 114,000. The unemployment rate is expected to dip to 4.2% from 4.3% in July. Year-over-year growth in average hourly earnings is estimated at 3.6%, down from 3.7% in July. Stronger than anticipated reports could cause the stock and bond markets to falter on fears of delayed or fewer rate cuts from the Fed.

Roger Khlopin, CFA
Chief Investment Officer

Aaron Nghiem, CFA, CIMA
Senior Portfolio Manager