Dear Friends,
Though August started with a negative market reaction to positive earnings, it ended with an impressive rally for the past two weeks. The IRS has also been busy this month and recently provided updated guidance with respect to the SECURE 2.0 Act and Roth catch-up contributions which we previously discussed in July. Find out more about these updates in this week’s newsletter.
SECURE 2.0 Roth Catch-up Contributions Postponed
The IRS announced late last Friday, August 25, 2023, that it will provide a two-year transition period for the SECURE 2.0 Act provision that requires catch-up retirement contributions by highly compensated employees to be made as after-tax Roth contributions. This means that employers will not be required to comply with this requirement until 2026. Under §603 of SECURE 2.0 Act, participants aged 50 and older in an employer 401(k), 403(b), or 457(b) plans whose wages exceeded $145,000 from that employer in the prior taxable year must make catch-up contributions on a Roth basis starting in 2024. The IRS’s new two-year transition rule, pushing this requirement out until 2026, allows employer plans and participants more time to prepare for this change
Economy, Geopolitics, and Commodities
1. Powell Says Fed Will ‘Proceed Carefully’ on Further Rate Rises
At the Jackson Hole Economic Symposium, Federal Reserve Chair Jerome Powell argued for holding interest rates steady for now but kept the door open to raising them later this year if the economy doesn’t slow enough to keep inflation declining. Powell’s heavily anticipated address at the Kansas City Fed’s annual symposium underscored how he is trying to thread the needle between restraining the economy enough to reduce price pressures without throwing it into a needlessly severe slowdown. Powell twice said the Fed would “proceed carefully” in any further move, signaling he saw little urgency to raise rates at the central bank’s next policy meeting in September. “Given how far we have come, at coming meetings we are in a position to proceed carefully,” as officials “decide whether to tighten further or, instead, to hold the policy rate constant and await further data,” he said delicately scripted remarks.
Powell noted recent signs the economy might not be slowing as officials expect. They have anticipated inflation to decline further because they expect the economy to grow below its long-run trend of around 2% over the coming year. Powell said additional evidence that the economy might instead grow above that trend rate “could put further progress on inflation at risk and could warrant further tightening of monetary policy.” Stocks swung between gains and losses after Powell’s speech, before closing higher. The S&P 500 and the Dow Jones Industrial Average each climbed 0.7%, and the Nasdaq Composite rose 0.9%. The yield on the benchmark 10-year Treasury note increased to 4.239% on 08/25. Fed officials lifted their benchmark federal funds rate last month by a quarter-percentage point to a range between 5.25% and 5.5%, a 22-year high, continuing the most rapid series of increases in four decades. Their next meeting is Sept. 19-20.
2. U.S. Second Quarter GDP Growth Revised Lower
U.S. economic growth was revised lower to a still-solid pace in the second quarter, but momentum appears to have picked up early in the third quarter as a tight labor market underpins consumer spending. Gross domestic product increased at a 2.1% annualized rate last quarter, the government said on Wednesday in its second estimate of GDP for the April-June period. That was revised down from the 2.4% pace reported last month. Economists polled by Reuters had expected GDP for the second quarter would be unrevised. The revision reflected downgrades to inventory investment as well as business spending on equipment and intellectual property products. The economy grew at a 2.0% pace in the first quarter and continues to push ahead despite 525 basis points worth of interest rate hikes from the Federal Reserve since March 2022. It is expanding at a pace well above what Fed officials regard as the non-inflationary growth rate of around 1.8%.
The economy’s resilience raises the risk of borrowing costs remaining higher for a while, but slowing inflation is fueling optimism that the U.S. central bank is probably done hiking rates and could engineer a “soft landing.” Most economists have walked back their forecasts for a recession this year. Though the labor market is slowing, with job openings dropping to the lowest level in nearly 2-1/2 years in July, employers are largely hanging on to their workers after difficulties hiring during the pandemic. That is keeping wage growth elevated, helping to drive consumer spending. Retail sales increased strongly in July, while single-family homebuilding was robust. Economists have boosted their third-quarter growth estimates to as high as a 5.9% rate, though this likely overstates the health of the economy.
3. Job Gains Eased and Unemployment Increased in August
Hiring cooled this summer and unemployment rose in August, signs the labor market is moderating in the face of high interest rates. U.S. employers added 187,000 jobs last month, while payrolls in June and July were revised down a combined 110,000, the Labor Department said Friday. The monthly gain in August was well less than the average pace over the prior year, and far below the roughly 400,000 average monthly gain in 2022. The unemployment rate was 3.8% last month, up from 3.5% in July. Workers’ average hourly earnings rose 4.3% in August from a year earlier, slower than last year but well above the pre-pandemic pace. Healthcare, leisure and hospitality, social assistance, and construction establishments increased their hiring, while employers in transportation and warehousing cut staff.
The Federal Reserve is closely watching the labor market. Fed Chair Jerome Powell signaled on Aug. 25 that the central bank could hold rates steady at its September policy meeting but kept the door open to raising them in coming months if the economy doesn’t weaken more. Inflation is down sharply from its June 2022 peak, but Fed officials have said that resurgent economic activity and elevated wage gains could keep it from returning to its 2% target. Falling demand for workers that loosens the labor market without triggering mass layoffs is the ideal outcome for the economy, said Luke Tilley, chief economist at Wilmington Trust Investment Advisors. “We have a slower economy, and that is weighing on job growth, but it’s still pretty strong,” he said before the data release. “That is going to be the key to a soft landing because consumers aren’t going to cut back in a massive way and retrench if we continue to have net job growth.” A soft landing is an outcome in which the economy cools enough to control inflation without plunging into a recession.
4. U.S. Home Sales Extended Prolonged Slump in July
Home sales fell in July for the fourth time in five months, extending one of the deepest housing slumps in recent memory. Sales of existing homes, the majority of purchases, decreased 2.2% in July from the prior month to a seasonally adjusted annual rate of 4.07 million, the National Association of Realtors said Tuesday. That was the slowest monthly sales pace since January and the slowest July pace since 2010. The combination of high mortgage rates, near-record home prices, and limited inventory has been suffocating sales, which were down 16.6% from a year earlier in July. With mortgage rates last week rising back above 7% to a two-decade high, sluggish home sales activity is expected to continue for a while.
“Two factors are driving current sales activity—inventory availability and mortgage rates,” said Lawrence Yun, NAR’s chief economist. “Unfortunately, both have been unfavorable to buyers.” The Federal Reserve’s campaign of raising interest rates to curb inflation is putting upward pressure on mortgage rates. And a limited supply of homes is keeping prices high. The national median existing-home price rose 1.9% in July from a year earlier to $406,700. It was the fourth time on record that this figure had risen over $400,000, NAR said. Economists surveyed by The Wall Street Journal had estimated sales of previously owned homes to fall 0.2% in July. Though there are fewer home buyers now than a year ago, languid levels of supply are keeping prices from falling, when viewed annually. Home prices have risen much faster than Americans’ incomes since 2000, Yun said, creating an affordability gap that is also holding back sales. Total sales inventory stood at 1.11 million units in July, down 14.6% from the same month last year, NAR said. Buyers who do pull the trigger today can’t count on discounts.
5. Stubborn Inflation Proves Difficult to Tame in Europe
Eurozone inflation remains stubbornly high even as other signs point to a slowing economy, presenting the European Central Bank with the tricky task of cooling already anemic demand without pushing the region into a prolonged recession. The surge in energy and food prices that followed Russia’s invasion of Ukraine has left the eurozone with higher inflation and weaker growth than in the U.S. When ECB policymakers raised the bank’s key rate last month, they signaled that they might pause at their next meeting, which is scheduled for Sept. 14. Since then, there have been signs that the economy is weaker than they had anticipated, but inflation has been stronger.
The European Union’s statistics agency Thursday said consumer prices were 5.3% higher in August than a year earlier, unchanged from July. That is well below the 10.6% peak reached in October 2022, but substantially above the ECB’s 2% target. Economists had expected to see a decline in the inflation rate, which rose in both France and Spain, two of the eurozone’s largest members. The surprisingly rapid rise in prices increases the likelihood that the ECB will raise its key rate for the 10th time next month. “Should we judge that the policy stance is inconsistent with a timely return of inflation to our 2% target, a further increase in interest rates would be warranted,” said Isabel Schnabel, a member of the ECB’s executive board, on Thursday. The inflation surprise was largely due to energy prices, which had declined in recent months but rose in August. The core rate of inflation, which excludes volatile items such as energy and food, fell to 5.3% in August from 5.5% in July. One worry policymakers have is that inflation isn’t falling fast enough to persuade workers not to press for large pay rises to protect their spending power—a mechanism that has historically made inflation stickier and harder for central banks to bring down.
6. Chinese Banks Plan Deposit Rate Cuts
Large commercial banks in China are planning to lower some deposit rates starting Friday, softening the blow of mortgage rate cuts that will further squeeze their profit margins at a crucial economic juncture. Major state-owned banks are expected to cut interest rates on time deposits by up to a quarter of a percentage point, according to a Chinese state media outlet. A customer service representative at one of the country’s biggest banks confirmed on Thursday that rates on its one-year deposits would be trimmed by 0.1 percentage point, while those on three- and five-year time deposits would be cut by 0.25 percentage points. One lender, Industrial Bank, announced its new deposit rates late Thursday night.
The deposit rate cuts will help cushion banks from taking another big hit to their profits after regulators pushed through widely anticipated changes to mortgage rules on Thursday. Chinese commercial banks can now reduce the rates they charge on existing loans, a move partly designed to discourage a recent trend of Chinese citizens using their money to pay back mortgages rather than spend in restaurants, bars, and shops. The exact size of the cuts will still be left to commercial banks and their customers to negotiate. The central bank has set a floor for how cheap loans can be, compared with a benchmark rate. The country’s banks have been doling out cheaper corporate and personal loans to help stimulate the flagging economy. The People’s Bank of China has cut a key lending rate twice in the past year, and commercial banks have trimmed loan benchmarks that are used to price mortgages and other debt. Those moves have come at a significant cost to lenders. Several large banks that released first-half results this week said their net interest margins—which reflect the difference between what they earn from their assets and what they pay for deposits and other funding—dropped to new lows. Large Chinese banks’ time deposits currently earn 1.25% to 2.5% annually. Many of them have slashed their deposit rates already this year.
Financial Markets
1. Dow Closes More than 100 Points Higher
Stocks were little changed Friday as traders weighed the latest U.S. jobs report to conclude a winning week. The Dow Jones Industrial Average ticked up 103 points, or 0.3%. The S&P 500 added 0.1%, and the Nasdaq Composite slipped 0.1%. The major averages were up sharply earlier in the day. The Dow briefly traded more than 250 points higher, while the S&P 500 and Nasdaq climbed 0.8% each before easing. The 10-year Treasury yield climbed. It rose to 4.173%, up from its closing level of 4.09% on Thursday. The S&P 500 and Dow were up 2% and 1%, respectively, for the week. That puts them on track for their biggest weekly advance since July. The Nasdaq is up nearly 3% week to date, also on pace for its best one-week performance since July.
Dell Technologies surged 22.4% on Friday after exceeding analysts’ second-quarter expectations. The computer company reported adjusted per-share earnings of $1.74 and revenue of $22.93 billion. Analysts polled by Refinitiv anticipated per-share earnings of $1.14 and $20.85 billion. Morgan Stanley also named Dell a top pick in IT hardware.
Shares of the tech giant Apple were rising for the sixth day in a row on Friday, putting them on pace for their longest winning streak since March 29, 2022, when they rose for 11 consecutive trading days, according to Dow Jones Market Data. The stock gained 0.5% to $188.82 in late morning trading on Friday. This year, it has jumped 45%.
Walgreens Boots Alliance stock was having its worst day in more than a decade after the healthcare giant announced its chief executive officer is stepping down. Shares dropped 3.6% to $24.39 in late morning trading Friday, putting them on pace for their lowest close since March 20, 2009, when they closed at $24.29, according to Dow Jones Market Data. The stock was also the worst performer in the Dow Jones Industrial Average. This year, shares have tumbled 35%.
2. Intel to Accelerate Arizona Fab After Getting Large Customer Order
Intel shares are gaining ground late in Thursday’s trading session after CEO Pat Gelsinger said that third-quarter financial results are running above the midpoint of the company’s guidance range. Intel had previously forecast third-quarter revenue of between $12.9 billion and $13.9 billion. Gelsinger made the comment at a Deutsche Bank investment conference. The Intel CEO also said that the company has received “a large customer prepays” for “18A” manufacturing capacity, a reference to the company’s development of 1.8-nanometer production lines, which will be used to produce cutting-edge chips. Based on that prepayment, Gelsinger said, Intel is accelerating construction of its new chip fabrication facility in Arizona. “Overall, everything is coming together,” he said. “And this customer prepay really is a strong exclamation point to momentum for 18A and the manufacturing capacity for that.” Gelsinger didn’t say which customer had prepaid for manufacturing capacity.
Intel has been making a major push to expand its foundry business, manufacturing chips on behalf of other device companies. The company is building out all new fabs in both Arizona and Ohio as part of that strategy. During the conference session, Gelsinger also responded to concerns that rapidly growing spending on Nvidia GPUs for AI applications might be crowding out demand for Intel’s own processors. He made the case that Intel will be “competing more for the GPU” market and that the AI trend will “create opportunities” for Intel’s CPU chips as well.
3. Salesforce Needs to Play Its AI Chips Wisely
Salesforce isn’t growing the way it used to. It also isn’t spending the way it used to. Keeping up the latter in the age of generative artificial intelligence will be the real trick. The cloud-software pioneer on Wednesday posted stronger-than-expected results for its fiscal second quarter. Revenue rose 11% year-over-year to $8.6 billion. That rate of growth matched that of the previous quarter, which was a record low for a company that long had average growth rates well above 20%. But it also edged out Wall Street’s projections for 10% growth, as several analysts had expressed downbeat views ahead of the report about how Salesforce was tracking in an environment of constrained corporate technology spending. Earnings proved to be the bigger surprise. Adjusted operating income—the metric most closely watched by analysts tracking Salesforce’s performance—surged 77% year over year to $2.7 billion. That was 12% ahead of analysts’ projections, and it produced an operating margin of 31.6%, a record high for the 24-year-old company. Salesforce’s shares climbed around 6% in after-hours trading following the report.
Growing demand for generative AI services could end up testing Salesforce’s newfound resolve to keep delivering “profitable growth”—a phrase uttered by Salesforce executives seven times on the company’s conference call Wednesday. Those services, modeled after the popular ChatGPT tool released to the public late last year, require expensive chips and other components and are thus expensive to offer. For now, that cost is being borne mostly by cloud-computing giants including Microsoft, Alphabet’s Google, and Amazon.com, which are equipping their data center networks for such capabilities. Those costs will be passed down to businesses such as Salesforce, which use that infrastructure to power their own GenAI offerings. Salesforce announced pricing for some of its new AI tools in July and lifted prices on some of its other offerings, but some on Wall Street aren’t yet sold on the company’s prospects. Mark Moerdler of Bernstein noted that Microsoft is adding new AI features at no additional cost to its Dynamics customer relationship management software, which competes directly against Salesforce. “We are concerned that Salesforce is going to have difficulty monetizing AI,” Moerdler wrote in a note to clients recently.
4. Tesla Refreshes Model 3 and Slashes Prices of Top-End Cars
Tesla unveiled its long-awaited updated Model 3 with a longer range as it seeks to maintain its title as the world’s leading electric vehicle maker. The iteration has a sleeker and sportier look with slimmer headlights, as well as an added 8-inch display screen for rear-seat passengers, according to images on its website. One thing it doesn’t have that some analysts were expecting is a lower price tag. In China, where the vehicle first went on sale Friday, the refreshed Model 3 was priced at the equivalent of around $35,800 and up. That is 12% higher than the last starting price of the older version, which Tesla has stopped selling in the country. Also Friday, Tesla cut prices for its imported higher-end Model S and Model X cars in China, by around 14% and 21% respectively, two weeks after having lowered price tags for those cars in a bid to boost sales.
Tesla has announced its plans to commence deliveries of the updated Model 3 in the fourth quarter of this year. While customers in Asia, Europe, the Middle East, and Australia can now place orders, the U.S. market is still awaiting availability. Notably, prices for the Model 3 in Japan, Australia, and Germany have risen compared to the previous model. Despite growing competition in the electric vehicle market, Tesla has been relatively slow to introduce new products. The last major release was the Model Y in early 2020, with the Model S receiving its last update over two years ago. Investors are eager for the updated Model 3 to reinvigorate demand, with hopes for a lower price point to attract a broader audience. Tesla recently saw an 83% surge in global deliveries during the second quarter, thanks to price cuts and discounts. The company has also adjusted its production line in its Shanghai factory to prepare for mass production of the updated Model 3, which is set to begin this month. In China, Tesla is striving to maintain its competitive edge in the face of rising local competition and slowing EV sales growth, exacerbated by a price war impacting automakers’ profits.
5. Novo Nordisk Briefly Becomes the Biggest European Company
Danish drugmaker Novo Nordisk A/S momentarily surpassed French luxury powerhouse LVMH to become Europe’s most valuable company, buoyed by demand for its blockbuster obesity medicines. Novo’s market capitalization rose to the equivalent of just over $421 billion shortly after the start of trading on Friday, nudging past LVMH by a tiny fraction. It was only this year that the French luxury conglomerate passed the milestone of becoming Europe’s first company with a market value exceeding $500 billion, only for the stock to slip back. The success of Novo’s Wegovy and Ozempic injectable drugs has sparked something of a gold rush in the pharmaceutical industry and some analysts predict such treatments could become among the best-selling medicines ever. About 40 companies are chasing after Novo for a share of the market, led by Eli Lilly & Co., which expects to get US approval this year to use its Mounjaro diabetes drug to treat obesity.
Novo’s stock has more than quadrupled since the end of 2018, overtaking other European behemoths like Nestle SA, as well as pharmaceutical rivals Roche Holding AG and Novartis AG. The latest boost came in August when a landmark trial showed that Wegovy cuts the risk of heart disease by a fifth. The study may broaden access further by aiding Novo in reimbursement discussions with insurers who might otherwise balk at Wegovy’s cost. Also in August, the Danish company raised its profit and sales outlook for the year, citing growth fueled by demand for Wegovy and Ozempic. With the global market for obesity treatments expected to explode in the coming decade, Novo and Eli Lilly were in July tipped by Citigroup Inc. analysts to dominate what they described as a “structural duopoly.”
Sources:
(1) www.bloomberg.com
(2) www.factset.com
(3) www.wsj.com
(4) www.barrons.com
(5) www.cnbc.com
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. Economic forecasts set forth may not develop as predicted.
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Investing in stock includes numerous specific risks, including the fluctuation of dividends, loss of principal, and potential illiquidity of the investment in a falling market.
Investing in foreign and emerging market securities involves special additional risks. These risks include but are not limited to currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.
Investment advice offered through Private Advisor Group, a registered investment advisor and separate entity from The Legacy Foundation.
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