Update on the Markets:
| Index | 3rd Quarter 2023 | Full Year 2023 |
|---|---|---|
| S & P 500 (Large US Stocks) | (3.27%) | 13.07% |
| Russell 2000 (Small US Stocks) | (5.13%) | 2.54% |
| FTSE All-World ex-US (International Stocks) | (3.32%) | 5.86% |
| Barclays US Aggregate (Bonds) | (3.23%) | (1.21%) |
October 2023
Key takeaways
► Market downtrend
► Several Threats
► Growing federal debt
► Safety in bonds
September lives up to its reputation
Historically, September is the worst month for stocks. This year was no different. Soaring bond yields finally put a crimp in stock prices. The 10-year US Treasury Note yield rose from 3.86% on July 3 to 4.58% on September 29. Most of the increase occurred in the last few weeks. The market was volatile with up days followed by worse down days. In the end, you can see the resulting damage to stocks and bonds in the table above.
The good news is that the S&P 500 index is still clinging to double-digit returns year-to-date, thanks to Big Tech stocks (S&P7 or the “Magnificent 7”): Apple, Meta, Microsoft, Amazon, Nvidia, Google, and Tesla. Fueled by the AI frenzy, the median return on these stocks is 50% this year, while the remaining 493 stocks (S&P493) are mostly flat.
The weather could be clearer as we head into the last quarter of the year. The Federal Reserve signaled that there may be at least one more rate hike this year, but, more importantly, rates will stay higher for longer. The highly accommodating interest rate regime (almost zero at one point) we have seen since the Great Financial Crisis may be behind us – forever. It will take a while for stocks to adjust. The “higher for longer” is what really shocked the market this quarter. Investors were hoping for cuts in rates as early as February 2024. Looser money probably will not happen until the summer or even the end of 2024. You can earn over 5% in very safe money market funds –serious competition for stocks, especially growth stocks sporting lofty valuations. There are more storm clouds on the horizon.
Several Threats
- The Fed tightens too far First and foremost is the uncertainty of when the Fed will finish its rate hiking cycle and when cuts may begin.Always an issue. Will the Fed stick to its inflation target of 2.0%? The latest inflation print was 3.7% in August. Will the Fed overshoot? How quickly can we expect rates to fall? Fed policy can take 12-18 months to kick in. A recession may have already started. However, inflation data may show inflation to remain sticky, forcing the Fed to continue to raise rates (or at least keep them elevated for too long), resulting in a worsening recession.
- Slowing consumer spending Consumer confidence fell in September for the second time. Consumers are concerned about rising prices, especially groceries and gasoline. They also mentioned political instability and higher interest rates. There are signs that the job market is softening. Reduced hours worked, slower wage growth, fewer job openings, and lower quit rates all indicate hesitancy for employers and employees alike. Baby boomers are returning to the workforce. Employment remains strong, and workers see wage gains, but the increases often do not keep up with inflation. Higher rates in lending (think credit cards, auto loans, and mortgages) lower the demand for credit, and the lingering effects of the failures of Silicon Valley Bank and Signature Bank forced banks to tighten credit standards. The exhaustion of COVID savings and resumption of student loan payments on October 1 will further reduce discretionary spending.
- Growing government debt problem The dramatic increase in US federal debt and its growing cost (and Washington’s inability to deal with it) is finally coming into focus. US government debt outstanding has skyrocketed post the COVID pandemic – 25% added since early 2020. According to the Office of Management and Budget, net interest payments on the federal debt are estimated to be 6.8% of all federal outlays. It was 1.61% in fiscal 2021. We are paying more in interest on our $33 trillion debt than on national defense.
Larry Swedroe, Head of Financial and Economic Research for Buckingham Strategic Wealth, writes: Interest costs on the debt have increased from $1 billion per day in 2020 to almost $2 billion in 2023. The Cato Institute think tank reports that the country’s ever-expanding debt is now an issue of national security and that entitlement reform is a necessity, as the current growth rate of our debt is unstainable. The authors of the Cato Institute’s National Security Implications of Unsustainable Spending and Debt stated:Delaying responsible fiscal reforms in the face of growing federal debt invites economic and national decline. High and rising U.S. federal debt leads to suppressed private investment, reduced incomes, and increased risk of a sudden fiscal crisis. A weaker economy and growing concerns by international bondholders of U.S. treasuries about the government’s ability and willingness to service its debt – without resorting to high inflation – will drive up interest costs and eventually negatively impact America’s international standing. … National defense is a core responsibility of the federal government. To maximize Americans’ safety and prosperity, prudence should guide both strategy and the budget. A dire fiscal crisis would erode the economic foundation of America’s strength, limiting U.S. capacity to defend its vital interests at home and abroad.
Addressing growing entitlement programs (Social Security and Medicare, primarily) and increasing tax rates are the remedies. - Government shutdowns, aging demographics, the slowdown in China, trade tensions, geopolitical tensions, deglobalization, etc., are additional threats.
What to do?
Expect uncertainty and volatility. On top of economic issues, we now must worry about the very real possibility of a government shutdown next month. Be cautious about risk: slightly overweight bonds and longer maturities. One approach is to barbell your bonds. Keep a majority in money market funds and short-term bonds, then add on the long end to lock in today’s high rates. You can enjoy the highest yields since September 2007 – and they are only getting higher by the day! Rates may be at their peak. We may soon see economic weakness, and inflation is slowing (sticky, yes, but moving in the right direction). Ultimately, the price for beating inflation may be a recession where bond yields will drop significantly, resulting in tremendous capital appreciation (bond prices and yields move in opposite directions). And if rates edge higher in the meantime, returns may still be solid since you started with higher yields.
Please let me know if you have any questions or concerns.
Sincerely,
Henry
Henry Gorecki, CFP®
HG Wealth Management LLC
401 N Michigan Ave, Suite 1200
Chicago, IL 60611
312-723-5116
