Fall 2023 Market Commentary

October 13, 2023

Market Recap

For the quarter, U.S. stocks fell with the S&P 500 losing -3.3%. International stocks also lost ground, with the MSCI EAFE falling -4.1%. Bonds fell, with the Bloomberg Barclays Aggregate Bond Index returning –3.2%.


Following three consecutive quarters of positive returns for the stock market, the third quarter ended with a thud. July started the quarter nicely with a return for the S&P 500 of 3.2%. August began with an abrupt about-face that saw the index fall about -5% before recovering a bit to finish the month down -1.6%. Weakness continued in September and then accelerated dramatically to close out the quarter, with the month finishing down -4.8%. This more than offset the early gains and brought the index down –3.3% for the quarter.

*This graph is not intended to recommend any investment or investment activity.

The July peak ended a four month rally that saw the large cap index rise nearly 20% with little disruption. What changed in the quarter was that the labor market remained astonishingly resilient and the decline in inflation slowed. This caused the Fed to resume a more hawkish tone in their September meeting, indicating they are likely to raise rates again before the end of the year. They also laid out an extended timeline for keeping rates high to combat inflation. This brings market observers back to carefully watching what the Fed will do in reaction to positive economic data. Or in other words, good economic news is again bad news for the stock market, because a strong economy will most likely result in additional tightening measures by the Fed.

The update by the Fed that rates will remain “higher for longer” caused a dramatic response in the bond market, especially at the long-end of the yield curve. Longer maturity bonds saw yields jump substantially in a short period. The yield for the 10-Year U.S. Treasury bond jumped by more than a half of a percent to 4.6% over the course of the quarter. This has caused lending rates to continue to climb. Notably, the average rate for a 30-year fixed rate mortgage has climbed well above 7%, which is the highest mortgage rates have been since 2000. But as the chart below suggests, although elevated, rates have returned to a range that is still well within historical norms.

*Source: St. Louis Fed, This graph is not intended to recommend any investment or investment activity.

It appears now, following many years of accommodative monetary policy by the Federal Reserve, that the era of easy money is over. Low interest rates caused inflation to finally rear its head, which in turn caused the Fed to lift interest rates to a more normal (higher) range. Although it has created some uncertainty in the near-term, the economy has historically performed well in higher rate environments, so we’re confident that the economy can handle higher rates in the long-run.

There is, however, good reason for concern regarding the effect higher interest rates may have on the federal budget in the future. The amount of federal debt grew substantially during the recent period of exceptionally low rates. Now that bond yields are much higher, the cost for the U.S. government to borrow and refinance existing debts will increase dramatically in the coming years, making interest expenses a significant concern for the U.S. federal budget. It’s not that there aren’t solutions, but it will require difficult choices on taxes and federal spending to correct growing budget deficits going forward.

For our part, we’ve responded to higher interest rates in our portfolio by modifying our bond strategy. Since the 2008-09 global financial crisis, we have tilted our bond portfolio towards a short maturity/duration profile.  However, in light of the changing interest rate environment, we have decided to increase the duration of our bond portfolio. We implemented this change by selling a portion of our short-duration bond funds and reallocating to longer-duration bond funds. This shift allows us to position our bond holdings to benefit from the higher yields and should add some ballast in the event of a negative market event.  Duration measures a bond's sensitivity to changes in interest rates. A bond with a longer duration is more sensitive to interest rate fluctuations than one with a shorter duration.  Bond prices will generally increase if interest rates decrease, and vice-versa.

As noted above, the primary reason the Fed began raising interest rates last year was to fight inflation. After peaking at 8.9% last summer, inflation has been steadily declining. The most recent reading for August was 3.7% and economists expect inflation will continue to fall into next year. This means that the Fed is likely near the end of its tightening cycle, although they’ve indicated one or two more rate increases may occur before they are finished.

*Source: St. Louis Fed, This graph is not intended to recommend any investment or investment activity.

In spite of the turmoil in the lending markets, and defying widespread expectations that the Fed’s actions would lead to a recession, there is scant evidence that the economy is weakening. GDP is now expected to have grown 1-2% this year and will continue to grow at a similar pace next year. Unemployment remains exceptionally low with the labor market showing continued strength. Consumer spending remains robust, despite higher borrowing rates.

Due to the ongoing resilience of the economy, most strategists have changed their forecasts for a recession to expectations of continued growth for the remainder of the year, with little chance for recession in the near-term. Most also agree that if a recession occurs sometime in the coming year, it is likely to be mild. With these improved expectations, we remain optimistic that markets will continue to recover and reach new highs, hopefully in the near future.

Thank you very much for your continued confidence in our service and advice. If you would like to discuss our opinions, outlook, or your portfolio in greater detail, we would be happy to schedule a meeting or a conference call at your convenience. Lastly, don’t keep us a secret. If you know someone who would like help planning for their financial future, we will be pleased to speak with them to see if we can assist.