After a September swoon, which is fairly common, there were hopes among investors that the markets could experience an October rally. October did not provide respite from the selling pressure seen since August as interest rate and geopolitical concerns continue to weigh on performance.
The predominant factor in market performance, for both stocks and bonds, has been the trend of interest rates. The Federal Reserve direction on future rate changes is a hot button topic and the recent significant rise in long-term interest rates contributed to the headwinds for investors. The S&P 500 year-to-date performance peaked on Aug. 1. Since that time, the 10-year U.S. Treasury Yield (a proxy for long-term interest rates) has risen at an accelerated rate. This is a clear headwind for bonds, whose prices are directly and negatively influenced by rising rates, but stocks are also concerned about rising long-term rates and the impact on company growth expectations.
October also experienced a significant rise in geopolitical risk as a result of the Israel/Hamas conflict in the Gaza Strip. Certainly, the influence of these events on markets is secondary to the actual difficulties being experienced by residents of the region. It is, however, impactful to global economic sentiment because of the potential for further escalation and involvement by the U.S. or other oil-producing countries like Iran.
Another interesting wrinkle for stocks in 2023 is that a select few companies are driving the performance of the S&P 500. Seven of the largest holdings in the S&P 500 (Microsoft, Apple, Amazon, Nvidia, Alphabet, Meta, and Tesla) are up significantly on the year while the average stock performance has not kept up. As a result, these companies have grown larger and larger as a percent of the overall S&P 500 index. This level of market concentration is at historical highs, but that is not necessarily a positive or a negative. As investors look at performance, however, it is important to understand that diversified portfolios that don’t incorporate this level of concentration among the “Magnificent Seven” may look very different compared to the S&P 500.
We are also in the midst of company earnings, and several companies have provided updates both to how they are doing currently and what they see in the near future. The general trend has been better than expected for the quarter ended in September, but with slightly more caution on year-end. If current trends hold, however, this could be the first quarter of year over year growth since the third quarter of 2022 and trends are expected to accelerate higher as we move forward.
Overall, the market is providing a relatively mixed picture. Economic resilience, especially with the consumer, is a positive, but there are several potential pitfalls to future growth. As a result, we believe the best approach is prudence. A prudent approach doesn’t give up on stocks but allocates in line with an investor’s risk tolerance. A prudent approach understands that bond market performance has been negative for a longer period (due to rising interest rates), but as a result, yields from bonds are at much higher levels than they were in recent years. The positive of the current rate environment is that reducing portfolio volatility doesn’t come with significant loss in performance. Take caution though and remember that cash, while offering higher returns than the last several years, still likely underperforms stocks in the long term. Therefore, a prudent investment plan that incorporates lower risk assets blended with higher risk (but likely higher long-term growth) assets, is still the best choice for most investors.
Posted here on November 2, 2023 and written by Jeremy Bryan, CFA