After the S&P 500 experienced its best seven-month start to the year since 1997, stocks pulled back in the historically troublesome months of August and September. Although unenjoyable for investors, the slump may be necessary to set stocks up for a year-end rally.
- Stocks fell in August and September, but this was not surprising to us.
- The decline opens the door to a solid end-of-year rally in the historically strong fourth quarter.
- An overwhelming majority of the U.S. House and Senate voted to punt a shutdown for another 45 days.
- Student loan payments restart in October, but this is unlikely to dent consumption.
- Many borrowers already started making payments prior to the restart, and consumption has remained above the pre-pandemic trend.
- Other factors also suggest the economy may not be facing a consumption cliff.
The fourth quarter is typically the best quarter of the year for stocks. The S&P 500 is up nearly 80% of the time and by 4.2% on average, which is twice as strong as the next closest quarter historically, the first, which averages 2.1% growth. One reason the fourth quarter is historically so strong is it’s often rebounding off weakness in the third. This trend has played out so far this year.
The fact that stocks sold off in both August and September could indicate a strong fourth quarter. In fact, a review of past returns shows when both months were down at least one percent or more, such as they were this year, the fourth quarter was up 7.0% on average and has been higher 12 out of 13 times since 1950. So while investing hasn’t been fun the past few months, we wouldn’t bet against a late-year rally.
The Government Avoids a Shutdown
While a shutdown was expected by many, an overwhelming, bipartisan majority in the House and Senate voted this weekend to keep the government open for another 45 days at current funding levels and with additional funds for disaster relief. The House voted to extend by a 335-91 vote (with 90 Republicans and one Democrat dissenting), while the Senate voted 88-9 (with nine Republicans voting against). President Joe Biden signed the extension into law late Saturday night.
The legislation buys time for Congress to reach an agreement on spending over the next year. This is going to be a steep challenge, but for now the government will stay open and there will be no immediate impact on the economy. Note that markets have historically taken previous shutdowns in stride, as investors know the government will reopen eventually. As we noted last week, stocks have been higher during previous shutdowns, and stocks gained more than 10% during the last shutdown.
Why the Student Loan Restart Shouldn’t Crash the Economy
Student loans started accruing interest on Sept. 1, and payments become due starting Oct. 1 after a long pause. The federal government paused payments for all federal student loans, with no interest accrued, soon after the pandemic hit in March 2020. Since then, both the Trump and Biden administrations have pushed back the resumption of payments. The Biden administration also planned to forgive at least $10,000 in loans for about 43 million eligible borrowers; however, the Supreme Court struck this plan down over the summer.
It helps to review the numbers to figure out the scale of the issue here. Americans paid an average $6 billion per month toward student loans in 2019. Meanwhile, households spend about $1.5 trillion per month on consumption. The average monthly increase was about 0.3% in 2018-2019 (about $4.5 billion per month). Consumption has been running hot recently, averaging a 0.6% increase per month (about $9 billion).
The worry is that resuming the $6 billion a month spending on student loans will take a massive bite out of consumption growth, perhaps even wiping out all consumption growth for a few months. That would be a significant blow to an economy largely dependent on consumer spending. However, there are reasons this fear is likely unfounded.
The U.S. Department of Education has a seen a surge of payments recently. Over 30 days through Sept. 21, the government took in receipts of $9.4 billion. That’s well above receipts across any rolling 30-day period prior to the pandemic.
Interestingly, soon after the Supreme Court struck down the Biden administration’s forgiveness plan on June 30, payments started to go up. Receipts totaled $2.1 billion in July, up from just $1.2 billion in June. Then in August, payments exploded higher to $6.4 billion. September receipts are on track to be larger, adding up to $5.6 billion over the first three weeks of the month.
It may be that borrowers are looking to pay off loans before the official restart, especially high-income earners. Also, borrowers enrolled in new income driven repayment plans (IDR) may have already started payments. Borrowers who had automatic payments prior to the pause might have seen payments restart earlier than expected.
Whatever the reason, the big takeaway is that payments have surged, and more importantly the resumption of payments hasn’t adversely hit consumption yet. Consumption ran at an 8.1% annualized pace in July and August. After adjusting for inflation, consumption ran at a 4.2% annualized pace over those two months, twice the 2.1% annual pre-pandemic pace. As the chart below shows, there has been no letup in consumption recently.
Four Other Factors Also Suggest We’re Not Facing a Consumption Cliff
Student loan payments were never going to go from $0 to $6 billion on Oct. 1 for four reasons:
1) Many borrowers continued to make payments during the pause. Payments averaged $1.2 billion per month over the first six months of this year and $2.3 billion in 2021-2022. So, a lot of borrowers continued to pay down their debt even when they didn’t have to, and with interest suspended those payments went entirely to reducing principal.
2) The Biden administration recently canceled $116 billion in loans for more than 3.4 million borrowers. These were borrowers on income-driven repayment plans who were behind in their loan payoffs due to administrative errors. These borrowers typically had made 240-300 monthly payments already, or 20-25 years of a 30-year loan, so the rest of the debt was forgiven. About 1.1 million were misled by for-profit colleges and granted relief.
3) The Biden administration is also implementing a loan onramp for those who must resume payments. It will allow for consequence-free nonpayment for the first 12 months after restart, as nonpayers won’t be reported to collection agencies and credit bureaus. However, interest will continue to accrue.
4) A new plan (SAVE) will benefit another 20 million borrowers. It is estimated that SAVE will cut payments in half for these borrowers. Existing income-driven repayment plans are also becoming a lot more generous. SAVE raises the amount of money considered “non-discretionary,” which is protected from repayment requirements. This will lower payments significantly. For example, a borrower who makes $15 an hour will not make any payments. Borrowers earning more than this will save approximately $1,000 a year on payments. The plan also ensures that borrowers who keep up their minimum payments will not see their balances grow, i.e., additional interest above the minimum payment will not accrue to the balance.
There are more details to consider, but essentially, loan payments will not surge from $0 to $6 billion in October. And based on the Department of Education receipts and July-August consumption data, even a sudden surge of payments would not be enough to dent consumption.
We’re not saying there will be no impact. Consumer spending will probably ease up in the fourth quarter. But it’s unlikely to be enough of a decline to slow the economy significantly.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
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