September 30, 2023: Market Note
The good news is the equity (stock) markets are up on the year. The bad news is we did close out the quarter with a pullback. Every year has to have a worst month of the year and that month this year (so far) was September. The S&P 500 (best measure of the US stock market of the major indices) is down 4.9% this quarter and is down by 6.6% since July 31 (as of 9/30/2023).
To put that in perspective, the average annual drawdown is 12%. Our 6.6% retreat (from 7/31/2023 to 9/30/2023) is nothing at all unusual right now and markets need breathers.
The bond markets have also continued to experience weakness contributing to the 5.3% pullback in the 60/40 stock/bond balanced portfolio. The increase in rates associated with it is partly responsible for the weakness in equities. The following does indicate light at the end of the tunnel. To borrow from asset management firm Nuveen (subsidiary of TIAA) Chief Investment Officer, Saira Malik, the yield on the 10 year US Treasury usually stops rising a couple months before the final hike by the Federal Reserve which is probably November. That implies (based on history) that yields (interest rates) should be near their cycle highs, even though they have been ripping higher over the last month. The price in bonds bottom when the yields on bonds tops. Yields on bonds and prices of bonds move inversely.
We have been prepared for and writing about the potential for market weakness for multiple quarters. We have also been paying attention to the index of Leading Economic Indicators, which has been contracting for 17 months in a row. That number of consecutive months of contractions for the index has always presaged a recession of some degree. Of course this time could be different, but those are the famous last words of economists in nearly every market cycle who end up being wrong. There is even a book entitled “This Time is Different”, gently teasing those who have used that sort of language, again almost every market cycle seeking to deny economic and market reality.
There is an average of an 8 month lag (with a range of 2 – 17 months) from the time when the rate hikes by the Federal Reserve stop (which may be November) until the time that the recession begins, which pushes the recession out even further. Until a recession happens, if a recession happens, it is very possible the market could resume its previous rally and close out the year with strength.
In this kind of unknown environment where economists have been ‘waiting for Godot’ (their forecasted recession seems never to happen and is always just a little ways away), investors who are already in the market and invested should maintain discipline with respect to their investment strategy. For investors who are putting new money to work, dollar cost averaging (beginning immediately) is still appropriate when deploying new money into the market according to a systematic plan. That is very different than waiting till you get the all clear signal or feeling like things are calm and then jumping in. That “market timing” strategy is associated with underperformance because the market could continue rallying and missing out on those big up days in the market cannot undone. Missing the bigger up move days in the market, which the market offers every year (and which are unknown in advance) is a recipe for underperformance. Also the market usually recovers well before the end of a recession and when things do not appear calm so waiting unit the recession ends and market volatility measures subside is also associated with underperformance.
In summary, waiting until things feel calm has the potential for missing gains before and after the recession. The key reason why the market pays market returns is because there is short-term risk associated with it. I am intentionally using the term short-term to qualify the word risk because markets on an extended, longer time frame are not risky at all.
Here is what matters. We are confident that client portfolios in light of their goals and objectives are positioned appropriately. Broadly speaking that means the ability to participate when the market goes up but not to have too much exposure so that when the market goes down (and it will at times), investors have downside protection relative to the market. Of course, when markets go down, portfolios will go down, but the goal is to go down less than the market overall. We do that by having exposure to multiple asset classes and multiple (alternative) strategies that have different risk/return drivers and generally less correlation with other asset classes for overall smoother rides in portfolios. We include relevant market benchmarks (we include S&P 500, NASDAQ Composite and Bloomberg Aggregate Bond Index) along with quarterly statements to show portfolios’ relative performance and what we see regularly is a smoother ride than those indices.
 See Macrobond chart, 9/23/2023.