“Too Hot to Fish, but Financial Markets Getting Cold.”
As temperatures hit record highs this summer, the financial markets are experiencing a moderate cold snap. During August, the 10-year Treasury bond yield has pushed higher to 4.2%, oil has increased to over $80.00 per barrel, stocks have eased 4% from recent highs, and the U.S. Dollar has strengthened. All of these markets are influencing one another.
The most important issue is the Federal Reserve policy and if they plan to raise interest rates again. Oil is another issue, as half is used for transportation and half is used in the production of many products, including plastics, fertilizers, electronics, and food preservatives. Thus, oil is an important underlying ingredient to inflation. While the U.S. has increased domestic oil production by 8.8% since 2019, OPEC and Russia have reduced production. Recently, Saudi Arabia has reduced oil production to keep their profits high as China’s growth slows. Since the 1970’s, Saudi Arabia has not been a friend to the U.S. In addition, consumption of oil in the U.S. has declined, thanks to innovations to reduce oil usage and pollution control.
Chart Courtesy of JP Morgan Asset Management, Guide to the Markets, August 16, 2023
Fixed Income
Moving on to other markets, higher inflation from oil may push the Federal Reserve to raise interest rates even higher. Treasury bond yields have risen to highs for the year, partially due to concerns about Federal Reserve policy. The budget fiasco early this year led to substantial bond issuance, and now the U.S. Treasury is issuing a heavy allotment of bonds to replenish resources needed to keep the government operating.
Since interest rates impact the value of other financial instruments, significantly higher interest rates, for example, if the 10-year Treasury yield increases from 4.2% to 5%, this could push stock prices lower.
Stocks
Stocks have eased off from their recent highs primarily due to higher interest rates, and the Federal Reserve’s possible rate increases, China’s weakening economy, and most importantly, a decline in investor optimism. Investor psychology is a major factor in our investment analysis. Our tool to measure the short-term sentiment of investors is the put/call ratio. Recently, this indicator has been negative and has a way to go before the current downtrend reverses direction. As a result, we have taken a small “hedge” by purchasing securities that move opposite of the SP500 and the NASDAQ indices. Historically, August and September are weak months for stocks, so we are being cautious for the short-term.
Other Important Things
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