It was a very positive return month for stocks and bonds in November. After economic reports that reflected a calming inflation environment, assets rose in anticipation of a pause and potential reversal in restrictive Fed policy. As a result, November’s performance was one of the strongest months in several years.
As we stated in October, interest rate trends have been the predominant driver of market performance. Through summer and into the fall, interest rates rose at an accelerated pace and stocks and bonds were pressured as a result. During November, the inflation readings came in below expectations which set off a significant move downward in long-term interest rates. Investor sentiment has now shifted from expectations of continued Federal Reserve interest rate increases to looking at the potential for an extended pause and even potential cuts in 2024.
Further, while inflation is slowing, economic health remains relatively resilient. Job growth and the unemployment rate are holding relatively steady, and recent updates from companies show that consumers and businesses are still spending.
The bond market responded positively, as long-term interest rate declines have a positive influence on bond prices. Stocks followed the cues from bonds and economic data and also turned higher. Historical precedent shows that the stock market in the fourth quarter is often strong after a middling September. While October did not provide the respite from selling pressure, November’s performance was a welcome change of pace. Further strengthening this rally was the broader nature of the performance. After most of the year-to-date returns were driven by relatively few stocks, the performance in November had U.S. small-cap and international stocks performing in a similar fashion to their U.S. large-cap counterparts.
As we close the year, investors clearly have some tailwinds in their favor. Economic data is in the “sweet spot” between still growing but slowing enough for inflation to be better controlled. If these trends continue, this should ease the pressure on the Fed to continue to raise interest rates. The U.S. government, and our elected officials, have come together for a short-term compromise to avoid (for now) a government shutdown. Lastly, and most importantly for the stock market, corporate earnings have largely concluded with better-than-expected results in most sectors and with data suggesting that end market demand is resilient.
A word of caution, however, is that markets rarely go up in a straight line.
November was a very strong month and there is reason to be optimistic that these trends could continue. However, in the short term, investor sentiment and market performance can be fickle and turn on a dime. It is typically the unforeseen events that cause the most disruption. The markets are rarely, if ever, without concerns. Concerns are often present even in very good markets and a level of prudence and humility is typically a valuable strategy to guide investors in good times and bad.
In that regard, there is no need to significantly alter your investment plan to chase a rising market. A more prudent strategy is to assess whether your allocation to growth and safety assets is an accurate reflection of your long-term goals and risk tolerance. Using this as the guide, and doing the homework upfront, allows investors to stay the course during difficult times while still benefiting from the good times the market often provides. Lastly, this type of planning can overcome the pitfalls of increasing and decreasing risk based on emotion, which usually erodes rather than improves performance.
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.
After a September swoon, which is fairly common, there were hopes among investors that the markets could experience an October rally. October did not provide respite from the selling pressure seen since August as interest rate and geopolitical concerns continue to weigh on performance.
The predominant factor in market performance, for both stocks and bonds, has been the trend of interest rates. The Federal Reserve direction on future rate changes is a hot button topic and the recent significant rise in long-term interest rates contributed to the headwinds for investors. The S&P 500 year-to-date performance peaked on Aug. 1. Since that time, the 10-year U.S. Treasury Yield (a proxy for long-term interest rates) has risen at an accelerated rate. This is a clear headwind for bonds, whose prices are directly and negatively influenced by rising rates, but stocks are also concerned about rising long-term rates and the impact on company growth expectations.
October also experienced a significant rise in geopolitical risk as a result of the Israel/Hamas conflict in the Gaza Strip. Certainly, the influence of these events on markets is secondary to the actual difficulties being experienced by residents of the region. It is, however, impactful to global economic sentiment because of the potential for further escalation and involvement by the U.S. or other oil-producing countries like Iran.
Another interesting wrinkle for stocks in 2023 is that a select few companies are driving the performance of the S&P 500. Seven of the largest holdings in the S&P 500 (Microsoft, Apple, Amazon, Nvidia, Alphabet, Meta, and Tesla) are up significantly on the year while the average stock performance has not kept up. As a result, these companies have grown larger and larger as a percent of the overall S&P 500 index. This level of market concentration is at historical highs, but that is not necessarily a positive or a negative. As investors look at performance, however, it is important to understand that diversified portfolios that don’t incorporate this level of concentration among the “Magnificent Seven” may look very different compared to the S&P 500.
We are also in the midst of company earnings, and several companies have provided updates both to how they are doing currently and what they see in the near future. The general trend has been better than expected for the quarter ended in September, but with slightly more caution on year-end. If current trends hold, however, this could be the first quarter of year over year growth since the third quarter of 2022 and trends are expected to accelerate higher as we move forward.
Overall, the market is providing a relatively mixed picture. Economic resilience, especially with the consumer, is a positive, but there are several potential pitfalls to future growth. As a result, we believe the best approach is prudence. A prudent approach doesn’t give up on stocks but allocates in line with an investor’s risk tolerance. A prudent approach understands that bond market performance has been negative for a longer period (due to rising interest rates), but as a result, yields from bonds are at much higher levels than they were in recent years.
The positive of the current rate environment is that reducing portfolio volatility doesn’t come with significant loss in performance. Take caution though and remember that cash, while offering higher returns than the last several years, still likely underperforms stocks in the long term. Therefore, a prudent investment plan that incorporates lower risk assets blended with higher risk (but likely higher long-term growth) assets, is still the best choice for most investors.
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.
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.
