October 10, 2023 In the third quarter all asset classes fell primarily due to rapidly rising interest rates. The yield on the 10-Year Treasury Bond rose from 3.84% to 4.57%. How much damage could that cause? It seems like such a small amount. But any golfers out there know a small miss in your ball contact can lead to very bad results.
The broad bond market measured by the Aggregate Bond Index dropped 3.2% in the quarter, taking the index into negative territory year to date. Prior to last year the index had never had two losing years in a row and now there is the potential for a hat trick. If that happens, three consecutive years of negative returns would be unprecedented for the Aggregate Bond Index.
With the Fed focused on reducing inflation back to their target of 2% and the only major tool in their toolbox being rate increases, more difficulty for the bond market seems a reasonable possibility. As the talking heads on Wall Street debate the Fed’s ability to thread the needle between orchestrating a “soft landing” and sending the economy into recession, none of us can accurately predict how this story will end. Should employment remain relatively stable, we believe hope for a “soft landing” to be reasonable. It’s no surprise but equities also had a bad quarter. With interest rates on less risky bonds now in the 4% to 5% range, there are legitimate investment alternatives to the stock market. Many of us will remember not too many years ago the yield on our savings accounts being 0.01% or lower. Higher yields on our savings accounts is a silver lining of the Fed war on inflation.
Back to the stock market. The S&P 500 was down 3.3% while the Russell 2000 small stock index fell 5.1%. Similar losses were reported for Foreign Developed and Emerging Markets stocks. Nowhere to hide.
Piper Sandler, an Investment Bank, reported that 50% of the S&P 500 companies’ shares lost value while the other half gained value. Of the gainers, nearly all of the 13% year-to-date gain for the stock market can be attributed to the ten largest companies. Less disparity between winners and losers with a bit more sharing of the wealth would be a welcome change in the stock market going forward. Higher interest rates were also the leading culprit for the difficult third quarter in equities.
In recent memos, we pointed out that short-term interest rates were higher than long-term rates. This is not normal as longer-term investments are generally associated with higher rates of return. In economic speak, this is referred to as an inverted yield curve and that abnormal circumstance continues.
The war on inflation is not the only war raging. Sadly, the Ukrainians continue their fight with Russia and long-lived tension between Israel and Hamas has recently turned violent seemingly headed towards war. The “good news” (that phrase is difficult to even write) is the investment markets have shown a remarkable resiliency throughout history and our many military conflicts. Often, the best long-term investments are made during times of substantial uncertainty and even fear. While it is too early to say what the impact of the current military conflicts might be on our economy, there is substantial historical evidence that this too shall pass.
So, what’s an investor to do? As always and, perhaps now more than ever, we believe it important to resist the natural temptation to run for the hills and hide when the going gets tough. Instead, we believe investors should lean into the benefits of diversifying your portfolio and periodically rebalancing to sell some of the stuff that has done well and buy some of the stuff that has struggled (sorry to get so technical). As always, lean on our team here at Fairhaven with any financial planning questions.
Have a Happy Halloween!
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