Market Update October 18, 2023
After a promising first half of the year, stocks and bonds both gave up ground in the 3rd quarter. Blame can largely be cast on rising bond yields as the yield on the 10-year Treasury bond rose from 3.8% to 4.6% during the quarter. Recall that bond prices fall as yields rise due to the inverse relationship between prices and yields. Not all the blame can be attributed to the recent actions of the Federal Reserve this time around, as they only raised the Federal Funds rate once during the quarter, and by only a quarter of a point at that. Their dialogue about intending to keep rates higher for longer certainly was attributable to some of the increase in yields. Another contributing factor includes our government’s worsening financial condition as the rise in Treasury yields increases our government’s cost to service its debt. And, yields were held artificially low by the massive amount of bond buying the Fed did following the Covid crisis.
The good news is that bond yields are now the highest they have been since 2007. The yield on the 10-year Treasury is nearly 5% as of this writing. With yields up, the interest rate risk in bonds is now much lower than it was previously. While our strategy over the past two years of largely eschewing investment in traditional intermediate term bonds has served us very well, shifting our exposure instead to very short-term bonds and money market funds, I believe we are now to a point where it makes sense to reintroduce some duration (meaning lengthening maturities). It is refreshing to have bond yields back up again, and this greatly improves the outlook for bond returns over the longer term.
The difficult quarter for bonds led to a difficult quarter for stocks as well. The allure of higher bond yields can cause investors to pull money out of stocks and into bonds. Higher yields and high inflation can also weigh on stock valuations, making the high-valuation tech stocks that have led the market this year vulnerable. Thankfully, the valuation of stocks more broadly is in the range of reasonable to attractive, boding well for the outlook over the long-term for stocks too.
On the surface, somebody might think stocks have had a good year so far, with the cap-weighted S&P 500 up 13.1% through September. A closer look under the hood reveals a less inspiring year for stocks thus far. The stocks that make up the S&P 500 were up just 1.8% year to date as measured by the equal-weighted index in which all index components receive an equal weighting. Small company stocks have fared no better with the S&P 600 up 0.8% year to date. The MSCI Emerging Markets stock index was also up 1.8% year to date through September. The MSCI EAFE index of established foreign market stocks has fared better, up a respectable 7.1%.
I saw an interesting study recently by JP Morgan examining the subsequent 12 month returns of various asset classes following a peak in the yield on 6-month certificates of deposit (CDs) during previous rate hiking cycles. We may be at or very near a peak in short-term yields such as this. This study is very timely as investors are flocking to money market funds and short-term CDs, drawn by their attractive yields and safety. However, what the study revealed is that the subsequent 12 month return of stocks and bonds during those times in nearly all instances were much more attractive than that of 6-month CDs. Following the herd and straying from long-term investment strategies can have a detrimental impact on long-term returns.
I welcome the opportunity to discuss any questions or concerns you may have regarding your investment portfolio or any other needs you may have.
Sincerely,
Glenn S. Rank, CIMA®
Certified Investment Management Analyst®
President
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