From a market performance perspective, 2022 is a year most would like to forget. The first half of 2023 was a welcome reprieve. While we recognize that a well-diversified portfolio appreciates over a long period, we also know to expect interruptions along the way. The third quarter was one of those interruptions for 2023.
The Long View
Since 1909, there have only been four periods where the rolling 10-year annualized return of the S&P 500 Index has been negative. Two occurred in the late 1930s, which coincided with the stock market collapse and the Great Depression, and two occurred in the late 2000s, which coincided with the financial crisis and the Great Recession.
Looking back 10 years prior to those periods, we arrive at the Roaring Twenties and a thriving stock market, and the stock market bubble of the late 1990s. In other words, stocks had gotten well ahead of the economic fundamentals, and an economic event forced a longer-term retrenchment.
Here is one more statistic. Since 1909 (i.e., over the same period), stocks averaged a 10% annual return. Despite their volatility, stocks still outperformed savings accounts, CDs, T-bills, and bonds over the long term.
In third quarter 2023, stocks took a breather. When markets are seemingly priced for perfection, any disappointment may lead to a pullback. We’re not smart enough to time the stock market. It is impossible to predict the highs and lows of the stock market consistently.
Last quarter, Treasury yields moved higher with the 10-year Treasury yield hitting its highest level since 2007, according to data from the St. Louis Federal Reserve.
Few saw a bear market in 2022, and few expected the stock market to rally as it did the first half of 2023. In fact, many expected the economy to be in a recession by now, which would likely have created another impediment to stock market progress. We’re still waiting for that recession.
Historically, August and September have provided disappointing returns for investors according to monthly S&P 500 data from the St. Louis Federal Reserve. Unfortunately for investors, this year didn’t buck the averages. The S&P 500 Index finished lower for both months. In fact, the month of September ended lower for the fourth-straight year, ensuring third quarter 2023 ended lower as well.
|KEY INDEX RETURNS|
|Index||Asset Class||Q3, 2023||YTD||1-Year||3-Year|
|S&P 500||US Large Cap Core Stocks||-3.3%||13.1%||21.6%||33.7%|
|Russell 1000 Value||US Large Cap Value Stocks||-3.2%||1.8%||14.4%||37.0%|
|Russell 1000 Growth||US Large Cap Growth Stocks||-3.1%||25.0%||27.7%||25.9%|
|Russell 2000||US Small Cap Stocks||-5.1%||2.5%||8.9%||23.1%|
|MSCI EM||Emerging Markets Stocks||-2.8%||2.2%||12.2%||-4.0%|
|MSCI EAFE||International Large Developed Stocks||-4.1%||7.6%||26.3%||20.0%|
|Bloomberg Aggregate||US Investment-Grade Core Bonds||-3.2%||-1.2%||0.6%||-14.8%|
Source: Ycharts – Total Return (Monthly)
Behind the Scenes
Last quarter’s market decline cannot be attributed to economic weakness. In fact, the economy has been surprisingly resilient. Unexpected economic resilience may translate into stronger-than-expected corporate profits as companies report Q3 results this month.
There hasn’t been a significant increase in the rate of inflation either. Although gasoline prices have recently risen, the price hikes for most goods and services have moderated.
Despite some otherwise positive trends, a jump in Treasury yields and a continued hawkish tilt by the Federal Reserve generated stiffer headwinds.
Going Up, Down, or Holding Steady
The Fed held its key rate, the Fed funds rate, at 5.25%‐5.50% in September. While the pause was welcome, the Fed kept the door open for another .25 percentage-point rate hike this year. As of this writing, according to the CME FedWatch site, the Fed funds futures market puts a 70%+ probability that the Fed will continue to pause at the November policy meeting. (NOTE: with the October 7th invasion of Israel by Hamas and Israel’s subsequent retaliation, market predicters have further dropped the likelihood of a rate hike by the US Federal Reserve in the remaining months of 2023. It is a dynamic market, to be sure.)
Here is what we can be fairly certain of: While the rate increases may not yet be over, the pace of increases has almost certainly slowed compared to the 15-months starting in March 2022 when the Federal Reserve raised rates at the highest and fastest pace ever.
While prior projections have indicated the possibility of rate cuts next year, the Fed has now penciled in fewer 2024 reductions, according to its official projections. The phrase “higher for longer” regarding the Fed funds rate has become the Federal Reserve’s new mantra.
The parameters driving market performance really boil down to two things: economic performance and inflation. Yes, the rate of inflation has slowed, but inflation still remains roughly double the Fed’s 2% annual target.
The Fed is walking a tightrope. It hasn’t let up on its tough anti-inflation rhetoric and it hopes to continue to bring the rate of inflation lower. If they can do that without tipping the economy into a recession, all the better. Nevertheless, given the choice between lower inflation and avoiding recession, the Fed has made it clear that lowering inflation is clearly its goal.
Fed Chief Jerome Powell repeated the Fed’s 2% annual goal eight times in the opening remarks at the press conference that followed the Fed’s September, 2023 meeting. In contrast, investors had been betting that the Federal Reserve was finished raising interest rates while anticipating a more accommodative stance next year.
Without diving into the minutia and academic theory behind interest rates and stock prices, let’s keep it simple. Higher interest rates create stiffer competition for an investor’s dollar.
TINA No Longer
During the pandemic when interest rates were near-zero, the acronym TINA (There Is No Alternative) came into vogue. The acronym suggested that without risk, your portfolio return would be near zero, so there was no alternative to holding risk assets like stocks.
TINA is no longer the case. 10-year US Treasury yields are now pushing 5%. The real return is the difference between a risk-free rate, like that offered by Treasuries, and the inflation rate. In real terms, in early October the 10-Year Treasury inflation-protect securities yielded the highest it has been in 15 years (https://fred.stlouisfed.org/series/DFII10). Therefore, for those who try to time the market, one could conceivably choose to take risk off of the table for now and still earn a nice real return.
What Is An Investor To Do?
Successful investors look past seasonal anomalies and think long term.
While exercises that pinpoint general seasonal patterns make for an interesting discussion and may help uncover some of third quarter’s weakness, we contend that market timing and implementing strategies based on timing are not the best approach.
Instead, we suggest investors focus on what they can control. Some aspects of investment strategy and planning that each of us can control include:
- Long-term performance is about time in the market, not timing the market.
- Your behavior plays an important role in long-term returns. How do you react when stocks soar or falter? Does euphoria lead you to become too aggressive? Does market weakness push you to get too conservative after equities have already faltered?
- What is the best approach to your financial plan? Your mix of stocks, bonds and cash (and any other diversified asset class) plays a role. Much will depend on your appetite to take on risk.
It’s why we consistently emphasize your financial plan and your long-term goals. Successful long-term investors recognize that a disciplined approach is the shortest path to achieving financial objectives.
The plan isn’t etched in stone. It is flexible. When life brings about changes, we can make adjustments. But we encourage adjustments in the variables you can control.
I hope you have found this review to be informative. If you have any inquiries or wish to discuss any concerns, please don’t hesitate to contact me or any member of the Integrity Wealth Advisors team. As always, it’s a privilege to serve you and humbling that you have chosen us as your financial advisor. Thank you for the trust you have placed in Integrity Wealth Advisors.