by Jeremy Bryan, CFA

As we close the third quarter of 2023, investors are faced with a positive market for the year but also one that is currently in the midst of a market correction. There are multiple factors creating market tension, including higher interest rates, higher oil prices, and a threat of a government shutdown.

Bonds, after rebounding earlier in the year, are now facing a second year of decline after 2022 was one of the worst bond performance years on record. Rising interest rates continue to be the primary reason for bond malaise. Expectations about US Federal Reserve actions have shifted recently. Initially, expectations were for a potential pause cycle (which they did pause during the last meeting) and potentially cutting rates by end of 2023 or early 2024. These expectations have transitioned to “higher for longer”, where interest rates may stay at current levels or even rise into year end.

When interest rates rise fast, this creates uncertainty on a few fronts. First, the US consumer. When interest rates rise, borrowing becomes more expensive. Consumers looking for a home are certainly feeling this pain as the average payment on a house increases substantially when interest rates rise. Second, US businesses. Many businesses borrow money to add facilities, equipment, or add labor to continue to grow. When rates are rising, it creates issues on whether these projects are still profitable given the greater amount of interest payments for those loans. Lastly, for stock market investors, higher rates create higher bond coupon payments. For investors, many will determine that the income received from bonds and money market funds are now sufficient to avoid the volatility of the stock market and still achieve satisfactory returns. This, in turn, can be a headwind to market prices and the amount investors are willing to pay for stocks.

To be certain, interest rates aren’t the only concern. Investors have been dealing with substantially higher oil prices in the third quarter. This not only could increase inflation, but also acts as a tax on US citizens as transportation costs increase for themselves and the goods they purchase. Also, the threat of a US government shutdown was prevalent throughout the quarter with a last-minute stop gap solution providing only temporary respite.

So, given the issues described above, it is understandable that markets experienced a bit of a letdown in the quarter after a very strong start to the year. As we said in June, markets rarely progress upward in a straight line and corrections are a normal part of stock market investing. It is our opinion, however, that several things are still generally trending in a positive direction.

GDP Growth: Consensus expectations for US GDP growth has been rising throughout the quarter. This is a positive indication and offers a higher chance that we may be able to avoid an economic recession.
Core Inflation: This is the measure that the US Fed uses to assess inflation and make decisions on interest rates. These numbers have been in steady decline, and recent economic data also has provided an indication of slowing prices. If this is the case, Federal Reserve governors may be able to relax their stance on rates and reduce the chance that they overcorrect and push the economy into a recession.
Jobs: Job growth is slowing and the unemployment rate is rising. We should look at the data compared to history, however, and realize that the US economy is still experiencing low unemployment and jobs are still growing and not contracting.

Corporate Earnings Expectations: The expectations for earnings growth have been relatively steady even as the market has fallen. Consensus expectations show slight growth in earnings in 2023 but accelerating growth in 2024. Based on these earnings, and given the recent price declines, companies are generally cheaper now than they were at the end of second quarter.
For the remainder of the year, our outlook remains relatively optimistic but with the caveat that there are some storm clouds that we need to monitor. If interest rates continue to rise, either by Fed increases or general market conditions, it will be difficult for the market to rally significantly from current levels. This will be especially difficult if inflation, due to rising energy prices or other stimulants, begins to trend upward again. Lastly, jobs are never a great predictor of recessions as companies tend to wait until business is shown to slow before eliminating employees. If we see jobs go from growth to contraction, the US consumer may experience difficulties and may have to pull back on spending (consumer spending is the lifeblood of the US economy).

So, continue to invest in stocks, but there is no need to be overly aggressive in the current market. Own stocks for long term growth but also have a safety net by utilizing bonds, cash, or safe assets that are paying higher income than we’ve seen in many years. Remember, achieving your financial goals within the bounds of your risk tolerance is the only benchmark that matters. Having an investment plan that is suitable to your specific situation and uses a variety of tools to provide diversified return streams is still the best way of achieving your financial goals.

As we close the third quarter of 2023, investors are faced with a positive market for the year but also one that is currently in the midst of a market correction.  There are multiple factors creating market tension, including higher interest rates, higher oil prices, and a threat of a government shutdown. 

Bonds, after rebounding earlier in the year, are now facing a second year of decline after 2022 was one of the worst bond performance years on record.  Rising interest rates continue to be the primary reason for bond malaise.  Expectations about US Federal Reserve actions have shifted recently.  Initially, expectations were for a potential pause cycle (which they did pause during the last meeting) and potentially cutting rates by end of 2023 or early 2024.  These expectations have transitioned to “higher for longer”, where interest rates may stay at current levels or even rise into year end.

When interest rates rise fast, this creates uncertainty on a few fronts.  First, the US consumer.  When interest rates rise, borrowing becomes more expensive.  Consumers looking for a home are certainly feeling this pain as the average payment on a house increases substantially when interest rates rise.  Second, US businesses.  Many businesses borrow money to add facilities, equipment, or add labor to continue to grow.  When rates are rising, it creates issues on whether these projects are still profitable given the greater amount of interest payments for those loans.  Lastly, for stock market investors, higher rates create higher bond coupon payments.  For investors, many will determine that the income received from bonds and money market funds are now sufficient to avoid the volatility of the stock market and still achieve satisfactory returns.  This, in turn, can be a headwind to market prices and the amount investors are willing to pay for stocks. 

To be certain, interest rates aren’t the only concern.  Investors have been dealing with substantially higher oil prices in the third quarter.  This not only could increase inflation, but also acts as a tax on US citizens as transportation costs increase for themselves and the goods they purchase.  Also, the threat of a US government shutdown was prevalent throughout the quarter with a last-minute stop gap solution providing only temporary respite. 

So, given the issues described above, it is understandable that markets experienced a bit of a letdown in the quarter after a very strong start to the year.  As we said in June, markets rarely progress upward in a straight line and corrections are a normal part of stock market investing.  It is our opinion, however, that several things are still generally trending in a positive direction. 

• GDP Growth: Consensus expectations for US GDP growth has been rising throughout the quarter.  This is a positive indication and offers a higher chance that we may be able to avoid an economic recession. 
• Core Inflation: This is the measure that the US Fed uses to assess inflation and make decisions on interest rates.  These numbers have been in steady decline, and recent economic data also has provided an indication of slowing prices.  If this is the case, Federal Reserve governors may be able to relax their stance on rates and reduce the chance that they overcorrect and push the economy into a recession.
• Jobs: Job growth is slowing and the unemployment rate is rising. We should look at the data compared to history, however, and realize that the US economy is still experiencing low unemployment and jobs are still growing and not contracting.
• Corporate Earnings Expectations: The expectations for earnings growth have been relatively steady even as the market has fallen. Consensus expectations show slight growth in earnings in 2023 but accelerating growth in 2024.  Based on these earnings, and given the recent price declines, companies are generally cheaper now than they were at the end of second quarter. 

For the remainder of the year, our outlook remains relatively optimistic but with the caveat that there are some storm clouds that we need to monitor.  If interest rates continue to rise, either by Fed increases or general market conditions, it will be difficult for the market to rally significantly from current levels.  This will be especially difficult if inflation, due to rising energy prices or other stimulants, begins to trend upward again.  Lastly, jobs are never a great predictor of recessions as companies tend to wait until business is shown to slow before eliminating employees.  If we see jobs go from growth to contraction, the US consumer may experience difficulties and may have to pull back on spending (consumer spending is the lifeblood of the US economy). 

So, continue to invest in stocks, but there is no need to be overly aggressive in the current market.  Own stocks for long term growth but also have a safety net by utilizing bonds, cash, or safe assets that are paying higher income than we’ve seen in many years.  Remember, achieving your financial goals within the bounds of your risk tolerance is the only benchmark that matters.  Having an investment plan that is suitable to your specific situation and uses a variety of tools to provide diversified return streams is still the best way of achieving your financial goals. 

To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.