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Dear Friends,
As we’ve entered the last quarter of 2023, the encouraging start to the year in the stock market has recently taken a few steps back as investors adjust to the prospect of higher interest rates for a longer period of time.
August and September saw pullbacks in both equities and fixed income, with international and emerging markets faring slightly worse than US markets. Economic growth remains strong but is now showing signs of slowing. Wage growth has begun to taper from record highs of previous months, and inflation has also begun to tick up again, spooking investors and causing some near-term volatility.
The Federal Reserve met on September 20th and decided not to raise interest rates, but then indicated that another hike is not out of the question – and that interest rates could stay higher for longer than initially thought – with the prospects of a rate cut now looking much further out than previously expected. This uncertainty sent stock and bond markets in a downward trading pattern during the second half of September to close out the quarter.
As of the close of the market Monday, October 2, the S&P 500 is +8.62% YTD, the Barclays (Aggregate Bonds) -1.72%, and the MSCI Ex-US (International Stocks) 4.85%.
Much of the performance of the S&P500 this year can be attributed to the FAANG, now known as the MAMAA stocks (Meta, Apple, Microsoft, Alphabet, Amazon). These 5 mega-cap tech companies make up $9.2 Trillion of the S&P 500’s $36.45 Trillion total market cap, and these 5 companies are up a combined 57.8% year to date. If we were to take these companies' relative size out of the equation, an index of the equally weighted S&P500 companies is essentially flat this year. This outsized performance from just a few companies is a risk we will continue to monitor, and why we always stress diversification in our investment strategy.
On the international front, the war in Ukraine continues to rage on, and conflicts between China and Taiwan persist which has led to volatility in international markets as well. While we still believe that international markets present opportunities for investment growth and diversification long term, we are continuing to evaluate the cost and benefits of holding these investments and are further trimming our exposure to these markets in favor of large-cap companies that are based in the US. It is also worth noting that – due to the effects of globalization – exposure to multinational companies based in the US gives investors a higher exposure to investments overseas than it did 30 years ago.
Despite the underperformance of markets over the last quarter, we believe there is still a silver lining. The fourth quarter has historically been the strongest time of the year for markets. Between 1980-2022 the S&P 500 has generated average gains of 4.6%, compared to gains of 2.1%, 2.9%, and 0.3% for 1Q, 2Q and 3Q (Argus Research). Many also agree that the majority of interest rate hikes are behind us, so it is looking like a better time to begin stepping out of cash and into higher-yield fixed-income investments offering more attractive coupon payments (aka “dividends” for bonds).
There is also still a possibility we will avoid a recession via a “soft landing” with slower economic growth – but still growth over time – which would certainly benefit all markets long term. If we achieve a soft landing scenario, and the Fed does eventually cut interest rates even slightly, that would certainly result in a big tailwind for both stocks and bond markets and could happen quite rapidly. There are also widespread advancements in AI to consider, which are quickly becoming viable solutions for companies to increase their reach and reduce their costs via automated customer service, human resources, and marketing programs.
On the portfolio strategy side, we are maintaining a slight growth vs. value tilt in our equity portfolios leading into Q4, and are focused on tax loss harvesting and positioning fixed-income portfolios for longer duration and higher yields. We are rebalancing our qualified portfolios to make some of these investment changes, and updating portfolio targets in our taxable accounts to move them closer to our strategic allocation over time without triggering significant tax implications for clients. We continue to stay mid to short duration on bond investments to hedge against any further rate hikes by the Federal Reserve and are increasing quality and yields where it makes sense to increase portfolio income.
Overall, we continue to maintain a cautious yet optimistic approach for the rest of the year, and encourage clients to stay the course as we navigate what will likely be continued volatility over the next few months as the Fed closely monitors inflation and the overall health of the economy. Despite recent headlines, the underlying economic numbers are still good compared to even just a year ago. As we close out the year, we want to remind all clients that this volatility is normal and even healthy for an economy that likely got a little overheated from a worldwide pandemic and the resulting government stimulus and sweeping workforce changes that are still panning out.
At IEM, we stand by our philosophy of not trying to “Beat the Market” and seek to instead provide value to our clients through strategic investing and diversification that is forward-looking while avoiding the tendency to follow trends. This approach – in combination with comprehensive financial planning – is designed to provide the best possible investment outcomes for our clients.
In addition to our market commentary, we also recommend reading the Commonwealth Financial Network® 2023 Mid-Year Market Outlook for a more detailed look at the economic factors and research guiding our investment management decisions this year.
Sincerely,
Ted Smith, Founder & Chairman, RHU, CLU®, ChFC®
Danica Goshert, Senior Vice President, CFP®, CDFA®, AIF®, MBA
Dan LaNasa, Associate Vice President, CFP®
Charles Stewart, Associate Vice President, CFP®
Marcus Schaller, Manager of Financial Planning Services, CFP®, APMA™
Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.
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