Current Outlook & Portfolio Strategy
Posted on October 6, 2023
The third quarter is fully behind us and the end to another year is in sight. When reviewing the quarterly performance of the stock market, it is tempting to conclude that not much happened during the past quarter. The S&P 500, which represents the market-cap weighted performance of 500 large U.S.-based companies, ended the third quarter down 3%. Although the S&P 500 remained quite tame, the underlying economic sectors tell a slightly different story. The best-performing sector for the quarter was Energy. Oil prices climbed from $70/barrel to $90/barrel due to production cuts by Russia and Saudi Arabia. On the other hand, Information Technology, experienced a slight decline as the market took some time to digest its massive outperformance during the first half of the year. Nonetheless, the S&P 500 remains up 13% year-to-date.
A bright spot has been the relative broadening of participation among stocks. Through the first half of the year, just a handful of technology-related companies were responsible for most of the S&P 500’s return. Now, those companies are only responsible for 60% of the market’s performance. This is still a high concentration, but not near the levels of midyear. So, what are some potential reasons for the market pause this past quarter? We would attribute it to a couple of uncertain outcomes we faced near quarter-end: a potential U.S. government shutdown and the Federal Reserve’s (the Fed’s) course of action. We remain hopeful that Congress will have reached a compromise on a spending bill before any significant economic damage can be inflicted on the U.S. economy and populace, but it may be an 11th hour decision. So, let us move on to the Fed.
The Fed members returned from their August recess and chose to hold interest rates steady at 5.25 – 5.50%, which was widely expected by the markets. Throughout the year the Fed has reduced the magnitude and speed of their interest rate increases as they assess its delayed impact on inflation. While there remains a possibility that they could raise interest rates one additional quarter-point (0.25%) by year-end, the bigger question is: how long will they keep interest rates at peak levels? In other words, when will the Fed start cutting interest rates? Markets currently expect the Fed to start reducing interest rates during the first half of 2024. Interestingly, markets were expecting interest rate cuts to have already begun, so they have instead continued to push out the start date. Despite this delay in interest rates cuts, which would benefit stocks, the U.S. stock market seems largely indifferent to these shifting expectations.
The Fed also released their updated ‘dot-plots,’ which represent the anonymized Fed members’ predictions on the economy, inflation, and the future path of interest rates. The takeaway from this report is we should not expect interest rate cuts any time soon. In general, the median prediction from the Fed members largely agrees with the ‘higher-for-longer’ theme. Only time will tell. But a positive effect of these higher interest rates is that bonds are more attractive. The US 1-Year Treasury is yielding 5.5%, which may appeal to investors seeking a short-term, risk-free investment, while the U.S. 10-Year Treasury is yielding 4.6%. For further insights on the Fed and bond markets, please see the included article by Kristian Jhamb.
Our outlook for the fourth quarter is to expect market volatility to continue as the path forward may keep the markets on edge. Market participants will be monitoring the monthly economic reports (e.g., inflation readings, jobs growth) and quarterly company earnings reports as they seek to predict the near-term path of interest rates and whether the U.S. economy can withstand higher-for-longer interest rates. Currently, the U.S. economy continues to display resiliency. However, these data points can and do change month-to-month and quarter-to-quarter, so stock markets may fluctuate as the information is digested and acted upon. In the near-term, these volatile periods are best handled by understanding your near-term cash flow needs and ensuring those needs are met through an appropriate allocation to high-quality dividend stocks, short-term bonds, and cash. This will allow you to maintain an appropriate allocation to high-quality U.S. stocks (growth and dividend).
Andrew Vanderhorst, CFA, CAIA, CFP®
Chief Investment Officer
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