In the short run, markets can be volatile, expectations can change quickly and animal spirits can lead to euphoria or pessimism. Short term interest rate cycles, such as the one that started about 18 months ago, are still working their way through the economy. 10-year yields have fallen this past week from close to 5% toward 4.6%. Meanwhile, the S&P 500 has seen its longest winning streak (up seven consecutive days) in nearly two years. A lot of ground to cover in a short period of time.
The consumer has been resilient, but higher interest rates are having an impact on growth, lending and job creation. This week we got the latest edition of the Fed’s quarterly Senior Loan Officer Opinion Survey (SLOOS). The SLOOS report cited tighter lending standards for commercial and industrial (C&I) loans during the third quarter. Lenders noted a more uncertain outlook and reduced risk tolerance. Auto and credit-card loan standards also saw further tightening. After moderate growth in the second quarter, total household debt grew $228 billion, especially for credit cards and student loans. The increase is consistent with strong spending and GDP growth. But credit card delinquencies continue to rise from their historical lows seen during the pandemic and have now surpassed pre-pandemic levels.
The good news is that inflation is rolling over and central bank rate increases worldwide are starting to attenuate as higher interest rates bite. Even so, Minneapolis Fed President Neel Kashkari suggested this week that it is too soon to declare victory on the inflation front. On the flip side, Austin Goolsbee, Chicago Fed President, suggested this week that a “no landing” scenario is possible with declining inflation and continued economic growth.
Longer-term interest rate cycles can take decades to play out. However, investors have been looking for the Federal Reserve to start cutting rates shortly after the first rate hike back in March 2022. The Fed’s message has been relatively clear on fighting inflation and maintaining rates recently: higher for longer. The latest hope for rate cuts centers around mid-year 2024.
Warren Buffet, the “Oracle of Omaha,” has shown the value of long-term thinking and investing through market cycles. The Berkshire Hathaway annual meeting in Omaha typically attracts hordes of investors who camp out early to get a good seat, much like a major concert event. It’s not quite the Rolling Stones or Taylor Swift, but 30,000 people did attend the meeting this year. Having attended in the past, I can attest that there are no direct flights to Omaha from New York. You don’t have to sit through five hours of questions and answers, however, to know that Buffet’s message is value-oriented and quality focused, but also very long-term. As Buffet said, “Someone is sitting in the shade today because someone planted a tree a long time ago.”
Buffet’s company, Berkshire Hathaway# (BRK.A), reported quarterly results this week and provided a glimpse into broader trends in the economy. Berkshire posted a large increase in operating earnings, while sitting on a record amount of cash ($157 billion) as Buffett sees few acquisition opportunities. The equity markets remain “fairly valued,” which to Buffet means expensive. In the meantime, Buffet has been taking advantage of higher bond yields though, buying up short-term Treasuries yielding 5%.
In its insurance segment, Berkshire’s investment income for the quarter surged 75% from a year ago, mainly due to higher interest income, helped by a rebound in yields. The railroad business, including Burlington Northern Santa Fe, saw operating earnings drop 15%. It reported lower freight volumes offset by lower fuel costs. The company’s building products and industrial products groups saw revenue decline double digits. Broader economic indicators and third quarter corporate earnings reports in general have been signaling similar mixed trends.
Berkshire also posted unrealized losses on its investments of $24 billion as the stock market suffered a decline in the third quarter. Berkshire owns a concentrated stock portfolio and a large stake in Apple# (AAPL). The S&P500 index, mostly led by 7 of its largest stocks, is up 14.8% year to date. However, an equal weighted basket of S&P500 stocks is down slightly for the year.
Several years ago, an international airline started a 3-hour “flight to nowhere” that took off and landed at the same airport. When markets go sideways as they have done the last several months, it can seem like little progress is being made, similar to a flight that lands where it started. The setup for equity markets should be positive once the Fed is done tightening, assuming inflation is under control and the underlying economy remains healthy, still big “if’s.” No doubt we would all like to get there in a timely fashion.
Singer-songwriter Bonnie Raitt turns 74 today. Celebrity Chef Gordon Ramsay is 57 and David Muir of ABC news is 50.
Christopher M. Crooks, CFA®, CFP®