By John Lau,CPA, CFP®
October 2, 2023 – The S&P 500 started the third quarter largely the same way it ended the second quarter – with gains. Stocks rose broadly in July thanks primarily to “Goldilocks” economic data, meaning the data showed solid economic growth but not to the extent that would have implied the Federal Reserve needed to hike rates further than investors expected. That solid economic data combined with a decline in inflation metrics to further boost stock prices, as investors embraced reduced near-term recession risks and steadily declining inflation. The Federal Reserve, meanwhile, increased interest rates in late July but also signaled that it could be the last rate hike of the cycle. That tone and commentary further fueled optimism that one of the most aggressive rate hike cycles in history would soon come to an end. Finally, Q2 earnings season was better-than-feared with mostly favorable corporate guidance which supported expectations for strong earnings growth into 2024. Consequently, the S&P 500 rose to the highest level since March 2022 and the index finished with a strong monthly gain.
The market dynamic changed on the first day of August, however, when Fitch Ratings, one of the larger U.S. credit rating agencies, downgraded U.S. sovereign debt. Fitch cited long-term risks of the current U.S. fiscal trajectory as the main reason for the downgrade, but while that lacked any near-term specific justification for the downgrade, the action itself put immediate downward pressure on U.S. Treasuries, sending their yields meaningfully higher. The Fitch downgrade kickstarted a rise in Treasury yields that lasted the entire month, as the downgrade combined with a rebound in anecdotal inflation indicators and a large increase in Treasury sales stemming from the debt ceiling drama pushed yields sharply higher. The 10-year Treasury yield rose from 4.05% on August 1st to a high of 4.34% on August 21st (source: YCharts), the highest level since mid-2007. That rapid rise in yields weighed on stock prices throughout August and the S&P 500 posted its first negative monthly return since February, as higher rates pressured equity valuations and raised concerns about a future economic slowdown.
The August volatility subsided in early September, however, as solid economic data and a pause in the rise in Treasury yields allowed the S&P 500 to stabilize through the first half of the month. But volatility returned following the September Fed decision as the FOMC delivered markets a “hawkish” surprise, despite not increasing interest rates. Specifically, the majority of Fed members reiterated that they anticipated the need for an additional rate hike before the end of the year and forecasted only two rate cuts for all of 2024, down from four rate cuts forecasted at the June meeting. Then, late in the month, two additional developments weighed further on both stocks and bonds. First, the United Auto Workers labor union began a general strike, a move that would disrupt automobile production and temporarily weigh on economic growth. Second, the U.S. careened towards another government shutdown as Republicans and Democrats failed to agree on a “Continuing Resolution” to fund the government. The shutdown was avoided at the last minute, but the funding extension only lasts until November 17th meaning there will likely be another budget battle in the coming months. The S&P 500 declined towards the end of the month to hit a fresh three-month low, ending September down modestly.
In sum, volatility returned to markets during the third quarter, as rising bond yields pressured stock valuations, some inflation indicators pointed to a bounce back in inflation and the Fed reiterated a “higher for longer” interest rate outlook.
Fourth Quarter Market Outlook
Markets begin the fourth quarter decidedly more anxious than they started the third quarter, but it is important to realize that while the S&P 500 did hit multi-month lows in September and there are legitimate risks to the outlook, underlying fundamentals remain generally strong.
On growth, the “easy” part is now mostly behind us. It is not shocking that a spike in yields has not caused a slowdown, given high savings, low unemployment and the fact that rates have only been high for less than a year. But with each month that passes, that situation tilts more negatively. Excess savings are likely gone (or almost gone) and employment is showing some initial signs of deterioration and high rates matter more with each passing month. While there are reasonable concerns about a future economic slowdown, the latest economic data remains solid. Employment, consumer spending and business investment were all resilient in the third quarter and there simply isn’t much actual economic data that points to an imminent economic slowdown. So, while a future economic slowdown is certainly possible given higher interest rates, the resumption of student loan payments and declining U.S. savings, the actual economic data is clear: It isn’t happening yet.
On inflation: it is not hard for inflation growth to slow due to base effects when comparing to unsustainable levels of 2022. Going forward, the monthly data will become substantially more important. And with rising oil and commodity prices, the prospect of a bounce back in inflation is real and must be watched. So, fears that inflation may bounce back are legitimate, given the rally in oil prices in the third quarter. But the Federal Reserve and other central banks typically look past commodity-driven inflation and instead focus on “core” inflation, and that metric continued to decline throughout the third quarter. Additionally, declines in housing prices from the recent peak are only now beginning to work its way into the official inflation statistics, and that should see core inflation continue to move lower in the months and quarters ahead.
Finally, regarding monetary policy, the Federal Reserve’s historic rate hike campaign is nearing an end. And while we should expect the Fed to keep rates “higher for longer,” high interest rates do not automatically result in an economic slowdown. Interest rates have merely returned to levels that were typical in the 1990s and early 2000s, before the financial crisis, and the economy performed well during those periods. Yes, the risk of higher rates causing an economic slowdown is one that must be monitored closely, and we will definitely do that, but for now, higher rates are not causing a material loss of economic momentum.
Here’s what I think it all means. Data is driving this market and that isn’t changing anytime soon. But investors may be focusing too much on taking select data points that are surprisingly good or surprisingly bad and extrapolating out a larger narrative and that’s why we’ve seen an uptick in volatility. The key for this market going forward is to look through the “forest” of data and identify whether those longer-term risks are materializing, because if they are it will be time to get more defensive. But it will take more than one or two anecdotal data points to decide that. And that’s exactly what we will be focused on, cutting through the noise and monitoring the economic forest and not getting lost in the trees of individual data—because that will be the key to finishing 2023 strong and navigating what could be a more volatile 2024.
That said, as we begin the final quarter of 2023, we remain vigilant towards economic and market risks and are focused on managing both risk and return potential. We remain firm believers that a well-prepared, long-term-focused, and diversified financial plan can withstand virtually any market surprise and related bout of volatility, including “higher for longer” interest rates, stubbornly high inflation, geopolitical tensions, and recession risks.
At Robertson Stephens, we understand the risks facing both the markets and the economy, and we are committed to helping you effectively navigate this challenging investment environment. Successful investing is a marathon, not a sprint, and even intense volatility is unlikely to alter a diversified approach set up to meet your long-term investment goals.
Therefore, it is critical for you to stay invested and continue with the offensive/defensive tactical tilts, remain patient, and stick to the plan, as we’ve worked with you to establish a unique, personal allocation target based on your financial position, risk tolerance, and investment timeline.
We thank you for your ongoing confidence and trust. Please rest assured that our entire team will remain dedicated to helping you accomplish your financial goals.
Please do not hesitate to contact us with any questions, comments, or to schedule a portfolio review.
Sincerely,
John Lau
Our clients rely on us for timely information, and our job is to deliver.
Disclosure
Investment advisory services offered through Robertson Stephens Wealth Management, LLC (“Robertson Stephens”), an SEC-registered investment advisor. Registration does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. This material is for general informational purposes only and should not be construed as investment, tax or legal advice. The information contained herein was compiled from sources believed to be reliable, but Robertson Stephens does not guarantee its accuracy or completeness. Investing entails risks, including possible loss of principal. Past performance does not guarantee future results. This material is an investment advisory publication intended for investment advisory clients and prospective clients only. Robertson Stephens only transacts business in states in which it is properly registered or is excluded or exempted from registration. A copy of Robertson Stephens’ current written disclosure brochure filed with the SEC which discusses, among other things, Robertson Stephens’ business practices, services and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov. © 2023 Robertson Stephens Wealth Management, LLC. All rights reserved. Robertson Stephens is a registered trademark of Robertson Stephens Wealth Management, LLC in the United States and elsewhere.
Securities offered through Fortune Financial Services, Inc. Member FINRA/SIPC. Robertson Stephens Wealth Management, LLC and Fortune Financial Services, Inc. are separate entities and are not affiliated.
For information about Robertson Stephens, go to www.rscapital.com.
Higher Interest Rates Weigh on Stocks in the Third Quarter
By John Lau,CPA, CFP®
October 2, 2023 – The S&P 500 started the third quarter largely the same way it ended the second quarter – with gains. Stocks rose broadly in July thanks primarily to “Goldilocks” economic data, meaning the data showed solid economic growth but not to the extent that would have implied the Federal Reserve needed to hike rates further than investors expected. That solid economic data combined with a decline in inflation metrics to further boost stock prices, as investors embraced reduced near-term recession risks and steadily declining inflation. The Federal Reserve, meanwhile, increased interest rates in late July but also signaled that it could be the last rate hike of the cycle. That tone and commentary further fueled optimism that one of the most aggressive rate hike cycles in history would soon come to an end. Finally, Q2 earnings season was better-than-feared with mostly favorable corporate guidance which supported expectations for strong earnings growth into 2024. Consequently, the S&P 500 rose to the highest level since March 2022 and the index finished with a strong monthly gain.
The market dynamic changed on the first day of August, however, when Fitch Ratings, one of the larger U.S. credit rating agencies, downgraded U.S. sovereign debt. Fitch cited long-term risks of the current U.S. fiscal trajectory as the main reason for the downgrade, but while that lacked any near-term specific justification for the downgrade, the action itself put immediate downward pressure on U.S. Treasuries, sending their yields meaningfully higher. The Fitch downgrade kickstarted a rise in Treasury yields that lasted the entire month, as the downgrade combined with a rebound in anecdotal inflation indicators and a large increase in Treasury sales stemming from the debt ceiling drama pushed yields sharply higher. The 10-year Treasury yield rose from 4.05% on August 1st to a high of 4.34% on August 21st (source: YCharts), the highest level since mid-2007. That rapid rise in yields weighed on stock prices throughout August and the S&P 500 posted its first negative monthly return since February, as higher rates pressured equity valuations and raised concerns about a future economic slowdown.
The August volatility subsided in early September, however, as solid economic data and a pause in the rise in Treasury yields allowed the S&P 500 to stabilize through the first half of the month. But volatility returned following the September Fed decision as the FOMC delivered markets a “hawkish” surprise, despite not increasing interest rates. Specifically, the majority of Fed members reiterated that they anticipated the need for an additional rate hike before the end of the year and forecasted only two rate cuts for all of 2024, down from four rate cuts forecasted at the June meeting. Then, late in the month, two additional developments weighed further on both stocks and bonds. First, the United Auto Workers labor union began a general strike, a move that would disrupt automobile production and temporarily weigh on economic growth. Second, the U.S. careened towards another government shutdown as Republicans and Democrats failed to agree on a “Continuing Resolution” to fund the government. The shutdown was avoided at the last minute, but the funding extension only lasts until November 17th meaning there will likely be another budget battle in the coming months. The S&P 500 declined towards the end of the month to hit a fresh three-month low, ending September down modestly.
In sum, volatility returned to markets during the third quarter, as rising bond yields pressured stock valuations, some inflation indicators pointed to a bounce back in inflation and the Fed reiterated a “higher for longer” interest rate outlook.
Fourth Quarter Market Outlook
Markets begin the fourth quarter decidedly more anxious than they started the third quarter, but it is important to realize that while the S&P 500 did hit multi-month lows in September and there are legitimate risks to the outlook, underlying fundamentals remain generally strong.
On growth, the “easy” part is now mostly behind us. It is not shocking that a spike in yields has not caused a slowdown, given high savings, low unemployment and the fact that rates have only been high for less than a year. But with each month that passes, that situation tilts more negatively. Excess savings are likely gone (or almost gone) and employment is showing some initial signs of deterioration and high rates matter more with each passing month. While there are reasonable concerns about a future economic slowdown, the latest economic data remains solid. Employment, consumer spending and business investment were all resilient in the third quarter and there simply isn’t much actual economic data that points to an imminent economic slowdown. So, while a future economic slowdown is certainly possible given higher interest rates, the resumption of student loan payments and declining U.S. savings, the actual economic data is clear: It isn’t happening yet.
On inflation: it is not hard for inflation growth to slow due to base effects when comparing to unsustainable levels of 2022. Going forward, the monthly data will become substantially more important. And with rising oil and commodity prices, the prospect of a bounce back in inflation is real and must be watched. So, fears that inflation may bounce back are legitimate, given the rally in oil prices in the third quarter. But the Federal Reserve and other central banks typically look past commodity-driven inflation and instead focus on “core” inflation, and that metric continued to decline throughout the third quarter. Additionally, declines in housing prices from the recent peak are only now beginning to work its way into the official inflation statistics, and that should see core inflation continue to move lower in the months and quarters ahead.
Finally, regarding monetary policy, the Federal Reserve’s historic rate hike campaign is nearing an end. And while we should expect the Fed to keep rates “higher for longer,” high interest rates do not automatically result in an economic slowdown. Interest rates have merely returned to levels that were typical in the 1990s and early 2000s, before the financial crisis, and the economy performed well during those periods. Yes, the risk of higher rates causing an economic slowdown is one that must be monitored closely, and we will definitely do that, but for now, higher rates are not causing a material loss of economic momentum.
Here’s what I think it all means. Data is driving this market and that isn’t changing anytime soon. But investors may be focusing too much on taking select data points that are surprisingly good or surprisingly bad and extrapolating out a larger narrative and that’s why we’ve seen an uptick in volatility. The key for this market going forward is to look through the “forest” of data and identify whether those longer-term risks are materializing, because if they are it will be time to get more defensive. But it will take more than one or two anecdotal data points to decide that. And that’s exactly what we will be focused on, cutting through the noise and monitoring the economic forest and not getting lost in the trees of individual data—because that will be the key to finishing 2023 strong and navigating what could be a more volatile 2024.
That said, as we begin the final quarter of 2023, we remain vigilant towards economic and market risks and are focused on managing both risk and return potential. We remain firm believers that a well-prepared, long-term-focused, and diversified financial plan can withstand virtually any market surprise and related bout of volatility, including “higher for longer” interest rates, stubbornly high inflation, geopolitical tensions, and recession risks.
At Robertson Stephens, we understand the risks facing both the markets and the economy, and we are committed to helping you effectively navigate this challenging investment environment. Successful investing is a marathon, not a sprint, and even intense volatility is unlikely to alter a diversified approach set up to meet your long-term investment goals.
Therefore, it is critical for you to stay invested and continue with the offensive/defensive tactical tilts, remain patient, and stick to the plan, as we’ve worked with you to establish a unique, personal allocation target based on your financial position, risk tolerance, and investment timeline.
We thank you for your ongoing confidence and trust. Please rest assured that our entire team will remain dedicated to helping you accomplish your financial goals.
Please do not hesitate to contact us with any questions, comments, or to schedule a portfolio review.
Sincerely,
John Lau
Our clients rely on us for timely information, and our job is to deliver.
Disclosure
Investment advisory services offered through Robertson Stephens Wealth Management, LLC (“Robertson Stephens”), an SEC-registered investment advisor. Registration does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. This material is for general informational purposes only and should not be construed as investment, tax or legal advice. The information contained herein was compiled from sources believed to be reliable, but Robertson Stephens does not guarantee its accuracy or completeness. Investing entails risks, including possible loss of principal. Past performance does not guarantee future results. This material is an investment advisory publication intended for investment advisory clients and prospective clients only. Robertson Stephens only transacts business in states in which it is properly registered or is excluded or exempted from registration. A copy of Robertson Stephens’ current written disclosure brochure filed with the SEC which discusses, among other things, Robertson Stephens’ business practices, services and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov. © 2023 Robertson Stephens Wealth Management, LLC. All rights reserved. Robertson Stephens is a registered trademark of Robertson Stephens Wealth Management, LLC in the United States and elsewhere.
Securities offered through Fortune Financial Services, Inc. Member FINRA/SIPC. Robertson Stephens Wealth Management, LLC and Fortune Financial Services, Inc. are separate entities and are not affiliated.
For information about Robertson Stephens, go to www.rscapital.com.
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