Quarterly Market Letter Q3 2023

By Bruce Thompson on October 6, 2023

Client Letter October 2023

Market Odyssey: Navigating Difficult Waters

Is there no way of escaping Charybdis and at the same time keeping Scylla off my men?

-Homer, The Odyssey

That was Odysseus’ quandary as he attempted to sail, idiomatically, between a rock and a hard place. It is an apt metaphor for the current investment backdrop, as stock and bond investors navigate mixed signals for the economy and markets.

The sharp recovery following last year’s rough waters brought stocks to within hailing distance of a new high by early July. The rally was fueled partly by oversold conditions in the stock market, and partly by a growing belief that we may successfully steer through inflation and higher interest rates without a recession. Indeed, over the last year, CPI has declined sharply from an annual rate of over 9% to 3.7%, while the economy remains on track to grow about 2.3% for the year. 

In Q3, though, markets pulled back as investors came face to face with a tricky irony – continued resilience in employment, consumer spending, and housing prices may be watering down the Fed’s efforts to lower inflation back to the averages of the last few decades. 

In September, the Fed paused on hiking interest rates, citing reduced pressures on prices and the labor market as the reasons. But it also announced that it may keep rates higher for longer than hoped, creating a near-term headwind for stocks and bonds. 

As Milton Freedman famously said, “Monetary policy operates with long and variable lags.” The full force of the Fed’s rate hikes – 5.25% since early 2022 – won’t be known and felt until sometime in 2024, particularly as respects employment and housing, for which the impacts have been delayed in past cycles. Also, consumer spending has been resilient, but the combination of waning pandemic-related savings, the resumption of student loan repayments, the UAW strike, the recent upswing in oil prices, and rising consumer debt delinquencies will weigh on the markets’ calculus as we enter 2024. Meanwhile, the threat of a government shutdown has been averted at least temporarily with a last-minute deal in Congress. 

Q3 Market Summary

Stocks as measured by the core global MSCI All World Equity Index (ACWI) declined 4.1% in September and 3.4% for the third quarter. The ACWI is up 10.1% for 2023 and 19.8% for the last twelve months, but it remains about 6% below the January 2022 market high point. 

A market consolidation is to some degree “par for the course” after such a strong rally. Further, in our letter earlier this year, we pointed out that while the headline stock indexes had risen more than 20% since last fall, which technically counts as a new bull market, the relatively narrow scope of the advance posed doubts as to confidence in the rally. 

As you can see in the above table, so far this year the S&P 500 Index is up 13.1%. It has been boosted in an outsized way by returns in the Large Cap Growth (+28.4%) components of the index, primarily in a handful of large technology companies. The rally in tech stocks is being driven partly by excitement around artificial intelligence, and partly simply because they had dropped so much more during the correction last year. 

Meanwhile, returns this year in the broader market – including Value, Mid-Cap, and Small Cap stocks – have been more tepid than what one might expect to see in a full-throated bull market. With respect to value stocks, this again may be due partly to the fact that they held up better during the correction. But we suspect that a broader, more confident market recovery will require an “all clear” signal on interest rates.

During the third quarter, the much-watched inverted yield curve – the unusual spread between short and longer-term interest rates – narrowed because longer-term rates increased relative to short-term rates. As a result, the short-term bond index returned .7% during Q3 and about 2% for the year to date. But intermediate-term bonds as measured by the Bloomberg U.S. Aggregate Bond Index dropped 3.2% in Q3 and 1.2% so far in 2023. 

The recent bounce in longer-term rates may indicate confidence in the strength of the economy, but it could also reflect nascent concerns among investors worldwide about the trajectory of U.S. government debt.

That bond index yield now sits at 5.6% — about 1.9% above inflation. This is the first time in many years that bonds have offered a real return, an attractive proposition for investors compared with the end of 2021, when the yield was just 1.5% — about 1% below the inflation rate at the time. It also means that bonds are positioned to offer meaningful diversification in relation to stocks.

Concluding Thoughts

We pose the question, given investors’ recent counterintuitive “good news on the economy is bad news for the markets” predisposition, might any erstwhile slowdown in economic growth be considered a positive for both stocks and bonds, especially if it helps to take pressure off of inflation and interest rates? 

Only time will tell. Time is the crucial word, here. As cited in our Client Letter last April, historically it has taken two to three years to fully recover from a bear market, notwithstanding the quick bounce back from the Covid-related decline in 2020. In bidding stocks higher since last fall, investors’ hopes may have gotten a step ahead of fundamentals and realities on the ground.

Meanwhile, perhaps it makes sense to heed the advice Circe gave to Odysseus: “Pass those sirens by…stop your men’s ears with wax that none of them may hear!” 

In other words, tune out the incessant media noise and short-term forecasts. They are not reliable as evidenced by the nearly universal predictions for a recession last year, which has not come to pass. Following such siren calls may only dash your dreams – and financial plans – on the rocks of disappointment. 

Experience dictates that achieving investment success over the long term, which is the only term that really counts, especially if you’d like to keep Uncle Sam out of your pocketbook as much as possible, means staying patiently fixed on your course. 

Navigating through today’s mixed signals places more importance than ever on staying diversified and making sure you have staying power in your investments and mindset. This means assuring your asset allocation is right for your situation while maintaining enough cash and short-term holdings to meet expected and unexpected demands. 

Disclosure
Lexington Wealth Management is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC. This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors. All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. Lexington Wealth Management and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information or for statements or errors or omissions, or results obtained from the use of this information. Lexington Wealth Management and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice. This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.