2023 Q3
As you may know, I enjoy using farming and gardening analogies when I discuss financial topics because of growing up in farm country. In my last update, I briefly mentioned how I had planted a fig tree. I was amazed at the growth the tree put on this year with new branches growing up to 5 feet. In September, the tree was loaded with figs, but I noticed that none of the figs were ripening. I needed to pinch off the tips of the branches to stop the tree from growing, and to force it to put its energy into ripening the fruit. If the tree was allowed to grow unconstrained, the boughs would bend lower, the figs would remain inedible, and I would not get to enjoy the benefits of my hard work.
A market that puts on a fair amount of growth, also requires pruning to keep it from getting out of whack. In fact, even in the strongest bull markets, it is typical to experience 1 or 2 pullbacks per year, which can range from 5 – 7%, and maybe even up to 10%. As I mentioned in my last update, we believed technology companies were fully valued, and that we would like to see the breadth of the market widen. Like my fig tree, technology stocks, among other overvalued companies, were clipped in the third quarter, hopefully leading to a healthier market.
In addition to equities pulling back this past quarter, we saw a quick move in intermediate and long-term interest rates as well. By example, the 10-year Treasury jumped from 3.81% at the end of June, to 4.65% as of this writing. This is important as higher rates will force prices of quality bonds down.
Looking at current economic conditions, the economy is still growing, but at a decelerating rate. We also see a plethora of economic data that is, quite frankly, all over the place. What typically happens as we go through economic cycles is definitely not happening currently. The elongation of the cycle that I referenced in the last newsletter is still occurring. At this point, it looks like we could see the economy bottom in the latter half of next year, however we have different data points that point to lows throughout next year. Once again, typically the stock market cycle bottoms 6 to 9 months prior to the economic cycle bottoming.
We believe one of the biggest risks is the Federal Reserve’s (Fed) push toward its mandated 2% inflation target. If it truly wants to get there, it will need to slow the economy further. For the past year, we believed the Fed would back away from its 2% target, whether in its comments or actions. Backing away from this should have a positive impact on markets.
Inflation is still front and center, and while it continues to decline, it remains stubborn. The consumer is still healthy; however, the trend is towards declining sales in 2024 before rebounding in 2025. Link this with higher inventories for business, and we could potentially see more items on sale next year.
Other potential headwinds include the economy not yet feeling the full impact of higher interest rates, the inverted Treasury yield curve, the potential impact on regional banks of the commercial real estate market, and tightening credit. However, one of the positive signs, according to ITR Economics, is that Single Housing Starts, which leads the economy, are in a recovery phase. Real Personal Income is also at record highs and will probably remain there because of the tight labor market.
Looking ahead, we could see additional volatility during the first part of the fourth quarter with a potential rebound towards the end of the year. During upside movements, we would like to see the breadth of the market widen, allowing market gains to be broad-based across multiple sectors. In fixed income markets, traditional bonds are struggling due to the rise in interest rates, while our protective positions continue to perform well this year.
In summary, it is not surprising to see equity markets take a breather based on the current state of the economy and with the rise in markets so far this year. Our equity, and especially our fixed income portfolios, continue to perform well, and income in the portfolios is still climbing on average, with the expectation that this will continue.
As always, we will continue to take advantage of price fluctuations to add value to the portfolios.
If you have any questions, please let us know, and thank you for your trust.
Marc Henn, CFP®