Are You There G-d? Its Me Jon
Dear Clients and Friends,
You may note that this newsletter is a bit tardy in its arrival to your electronic doorstep. Original topics of discussion were family and traditions. But I think, due to recent tragic events, these observations may have to wait for the year-end letter.
Inspired by Judy Blume’s 1970 novel about a young girl coming of age and—among other worries—deciding her religion, I find myself lifting my head towards the sky and asking that same question.
Frequent readers of this foreword know that I am an unbridled optimist. I can always find a silver lining or recall seemingly world-ending events that have happy endings. However, even an optimist will have trouble discovering where the rainbow may be hiding.
We are forced to witness the death and destruction of our world on a constantly updating feed. There seems to be no escape from this. I believe it is normal to ask for G-d to respond in some way.
Like others, I have found the answers in talking to family, friends, and clients. I have witnessed so much outpouring of support for our communities and have witnessed the best of people in the face of hatred.
“Omnia Vincit Amore” or “Love Conquers All” was first uttered in the words of the ancient Roman poet Virgil. We all know it to be true. I saw this last weekend at a fourth-generation client’s wedding. I heard it in the trembling voice of a terminally ill client who felt it important to say “thank you” for taking care of his family. I felt it in the voice of a client talking about the birth of his first grandchild. I love that I can help families continue success, but I can’t pray long enough or hard enough to change the entire world. What I can do is try to help all of our families live a better life, so they have the ability to help others. Just like Margaret in Blume’s books, I know G-d is there because I have felt the beauty and kindness in this world. Hatred must not win. Dad and I stand ready to do our small part to help and promise to be with our clients on this journey we call life.
And now back to our regularly scheduled program…
A Return of Volatility
The S&P 500 rose to the highest level since March 2022 early in the third quarter but rising global bond yields, fears of a rebound in inflation and concerns about a future economic slowdown weighed on the major indices in August and September and the S&P 500 finished the third quarter with a modest loss.
The S&P 500 started the third quarter largely the same way it ended the second quarter – with gains. Stocks rose broadly in July thanks primarily to “Goldilocks” economic data, meaning the data showed solid economic growth but not to the extent that would have implied the Federal Reserve needed to hike rates further than investors expected. That solid economic data combined with a decline in inflation metrics to further boost stock prices, as investors embraced reduced near-term recession risks and steadily declining inflation. The Federal Reserve, meanwhile, increased interest rates in late July but also signaled that could be the last rate hike of the cycle. That tone and commentary further fueled optimism that one of the most aggressive rate hike cycles in history was soon coming to an end. Finally, Q2 earnings season was better-than-feared with mostly favorable corporate guidance which supported expectations for strong earnings growth into 2024. The S&P 500 rose to the highest level since March 2022 and the index finished with a strong monthly gain of more than 3%.
The market dynamic changed on the first day of August, however, when Fitch Ratings, one of the larger U.S. credit rating agencies, downgraded U.S. sovereign debt. Fitch cited long-term risks of the current U.S. fiscal trajectory as the main reason for the downgrade, but while that lacked any near-term specific justification for the downgrade, the action itself put immediate downward pressure on U.S. Treasuries, sending their yields meaningfully higher. The Fitch downgrade kickstarted a rise in Treasury yields that lasted the entire month, as the downgrade combined with a rebound in anecdotal inflation indicators and a large increase in Treasury sales stemming from the debt ceiling drama pushed yields sharply higher. The 10-year Treasury yield rose from 4.05% on August 1st to a high of 4.34% on August 21st, the highest level since mid-2007. That rapid rise in yields weighed on stock prices throughout August and the S&P 500 posted its first negative monthly return since February, as higher rates pressured equity valuations and raised concerns about a future economic slowdown. The S&P 500 finished August down 1.59%.
The August volatility subsided in early September, however, as solid economic data and a pause in the rise in Treasury yields allowed the S&P 500 to stabilize through the first half of the month. But volatility returned following the September Fed decision as the FOMC delivered markets a “hawkish” surprise, despite not increasing interest rates. Specifically, the majority of Fed members reiterated that they anticipated the need for an additional rate hike before the end of the year and forecasted only two rate cuts for all of 2024, down from four rate cuts forecasted at the June meeting. Then, late in the month, two additional developments weighed further on both stocks and bonds. First, the United Auto Workers labor union began a general strike, a move that would disrupt automobile production and temporarily weigh on economic growth. Second, the U.S. careened towards another government shutdown as Republicans and Democrats failed to agree on a “Continuing Resolution” to fund the government. The shutdown was avoided at the last minute, but the funding extension only lasts until November 17th meaning there will likely be another budget battle in the coming months. The S&P 500 declined towards the end of the month to hit a fresh three-month low, ending September down modestly.
In sum, volatility returned to markets during the third quarter, as rising bond yields pressured stock valuations, some inflation indicators pointed to a bounce back in inflation and the Fed reiterated a “higher for longer” interest rate outlook.
Third Quarter Performance Review
Rising bond yields were the main driver of the markets in the third quarter as high Treasury yields caused reversals in performance on a sector and index basis, relative to the first and second quarters.
Starting with market capitalization, large caps once again outperformed small caps, as they did in the first two quarters of 2023, although both posted negative returns. That relative outperformance by large caps is consistent with rising Treasury yields, as smaller companies are typically more reliant on debt financing to sustain operations and rising interest rates create stronger financial headwinds for smaller companies when compared to their larger peers.
From an investment style standpoint, however, we did see a performance reversal from the first two quarters of the year as value relatively outperformed growth in the third quarter, although both investment styles finished with a negative quarterly return. Rising bond yields tend to weigh more heavily on companies with higher valuations and since most growth funds overweight higher P/E tech stocks, those funds lagged last quarter. Value funds that include stocks with lower P/E ratios are less sensitive to higher yields, and as such, they outperformed in the third quarter.
On a sector level, nine of the 11 S&P 500 sectors finished the third quarter with a negative return, which is a stark reversal from the broad gains of the second quarter. Energy was, by far, the best performing S&P 500 sector in the third quarter thanks to a surge in oil prices. Communications Services also finished Q3 with a slightly positive quarterly return on hopes integration of advanced artificial intelligence would boost search and social media companies’ future advertising revenues.
Looking at sector laggards, the impact of rising bond yields was again clearly visible as consumer staples, utilities and real estate were the worst performing sectors in the third quarter. Those sectors offer some of the highest dividend yields in the market, but with bond yields quickly rising those dividend yields become less attractive and investors rotated out of the high-dividend sectors and into less-volatile bond funds as a result.
| US Equity Indexes | Q3 Return | YTD |
|---|---|---|
| S&P 500 | -2.08% | 13.07% |
| DJ Industrial Average | -1.28% | 2.73% |
| NASDAQ 100 | -1.30% | 35.37% |
| S&P MidCap 400 | -3.57% | 4.27% |
| Russell 2000 | -4.76% | 2.54% |
Source: YCharts
Internationally, foreign markets saw moderate declines and again lagged the S&P 500 in the third quarter as disappointing economic data in Europe and China bolstered regional recession fears. Emerging markets did relatively outperform developed markets, however, thanks to the announcement of larger-scale Chinese economic stimulus late in the quarter.
| International Equity Indexes | Q3 Return | YTD |
|---|---|---|
| MSCI EAFE TR USD (Foreign Developed) | -3.22% | 7.59% |
| MSCI EM TR USD (Emerging Markets) | -2.48% | 2.16% |
| MSCI ACWI Ex USA TR USD (Foreign Dev & EM) | -2.96% | 5.82% |
Source: YCharts
Commodities saw substantial gains and were the best performing major asset class in the third quarter thanks to a significant rally in the energy complex. Oil rose throughout the quarter on continued supply concerns as Saudi Arabia and Russia extended voluntary supply cuts to the end of the year. Meanwhile, demand estimates rose late in the third quarter following the aforementioned announcement of the large-scale Chinese stimulus plans, causing prices to rise sharply late in the quarter. Gold, meanwhile, declined moderately thanks primarily to the stronger U.S. dollar, which rallied steadily over the course of the third quarter, hitting a fresh 2023 high in September.
| Commodity Indexes | Q3 Return | YTD |
|---|---|---|
| S&P GSCI (Broad-Based Commodities) | 17.06% | 7.24% |
| S&P GSCI Crude Oil | 29.85% | 12.73% |
| GLD Gold Price | -3.10% | 1.40% |
Source: YCharts/Koyfin.com
Switching to fixed income markets, the leading benchmark for bonds (Bloomberg Barclays US Aggregate Bond Index) declined moderately for a second consecutive quarter as hawkish Fed rhetoric and hints of a rebound in inflation weighed broadly on fixed income markets.
Looking deeper into the bond markets, shorter-duration debt securities posted a positive quarterly return and outperformed those with longer durations in the third quarter, as the Fed did not signal it intended to raise interest rates any higher than previously expected. Longer-duration bonds, however, were pressured by the combination of a rebound in some inflation indicators and as investors digested that the Fed may well delay any rate cuts in 2024, keeping rates “higher for longer.”
Turning to the corporate bond market, lower-quality but higher-yielding “junk” bonds rose slightly while higher-rated, investment-grade debt declined moderately in Q3. The large performance gap reflected continued optimism from investors regarding future economic growth, as investors “reached” for higher yields offered by riskier companies amidst broadly rising bond yields.
| US Bond Indexes | Q3 Return | YTD |
|---|---|---|
| BBgBarc US Agg Bond | -2.94% | -1.21% |
| BbgBarc US T-Bill 1-3 Mon | 1.36% | 3.71% |
| ICE US T-Bond 7-10 Year | -4.20% | -2.86% |
| BbgBarc US MBS (Mortgage-backed) | -3.84% | -2.26% |
| BbgBarc Municipal | -3.95% | -1.38% |
| BbgBarc US Corporate Invest Grade | -2.59% | 0.02% |
| BbgBarc US Corporate High Yield | 0.80% | 5.86% |
Source: Ycharts
Fourth Quarter Market Outlook
Markets begin the fourth quarter decidedly more anxious than they started the third quarter, but it’s important to realize that while the S&P 500 did hit multi-month lows in September and there are legitimate risks to the outlook, underlying fundamentals remain generally strong.
First, while there are reasonable concerns about a future economic slowdown, the latest economic data remains solid. Employment, consumer spending and business investment were all resilient in the third quarter and there simply isn’t much actual economic data that points to an imminent economic slowdown. So, while a future economic slowdown is certainly possible given higher interest rates, the resumption of student loan payments and declining U.S. savings, the actual economic data is clear: It isn’t happening yet.
Second, fears that inflation may bounce back are also legitimate, given the rally in oil prices in the third quarter. But the Federal Reserve and other central banks typically look past commodity-driven inflation and instead focus on “core” inflation and that metric continued to decline throughout the third quarter. Additionally, declines in housing prices from the recent peak are only now beginning to work into the official inflation statistics, and that should see core inflation continue to move lower in the months and quarters ahead.
Finally, regarding monetary policy, the Federal Reserve’s historic rate hike campaign is nearing an end. And while we should expect the Fed to keep rates “higher for longer,” high interest rates do not automatically result in an economic slowdown. Interest rates have merely returned to levels that were typical in the 1990s and early 2000s, before the financial crisis, and the economy performed well during those periods. Yes, the risk of higher rates causing an economic slowdown is one that must be monitored closely, but for now, higher rates are not causing a material loss of economic momentum.
In sum, there are real risks to both the markets and the economy as we begin the final three months of the year. But these are largely the same risks that markets have faced throughout 2023 and over that period the economy and markets have remained impressively resilient. So, while these risks and others must be monitored closely, they don’t present any new significant headwinds on stocks that haven’t existed for much of the year.
That said, as we begin the final quarter of 2023, we remain vigilant towards economic and market risks and are focused on managing both risk and return potential. We remain firm believers that a well-prepared, long-term-focused, and diversified financial plan can withstand virtually any market surprise and related bout of volatility, including “higher for longer” interest rates, stubbornly high inflation, geopolitical tensions, and recession risks.
At Cohen & Son Wealth Management, we understand the risks facing both the markets and the economy, and we are committed to helping you effectively navigate this challenging investment environment. Successful investing is a marathon, not a sprint, and even intense volatility is unlikely to alter a diversified approach set up to meet your long-term investment goals.
Therefore, it’s critical for you to stay invested, remain patient, and stick to the plan, as we’ve worked with you to establish a unique, personal allocation target based on your financial position, risk tolerance, and investment timeline.
Any opinions are those of Jon Cohen and The Sevens Report and may not necessarily express the opinions of Raymond James. The information contained in this article does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance is not indicative of future results.
Material created by Sevens, an independent third party as of Oct.1 2023.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of the author and not necessarily those of Raymond James. Holding investments for the long term does not insure a profitable outcome. Keep in mind that there is no assurance that any strategy will ultimately be successful or profitable nor protect against a loss. Investing involves risk and investors may incur a profit or a loss.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The NASDAQ composite is an unmanaged index of securities traded on the NASDAQ system. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represent approximately 8% of the total market capitalization of the Russell 3000 Index. The S&P MidCap 400® provides investors with a benchmark for mid-sized companies. The index, which is distinct from the large-cap S&P 500®, measures the performance of mid-sized companies, reflecting the distinctive risk and return characteristics of this market segment. The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 22 developed nations. The MSCI ACWI ex USA Investable Market Index (IMI) captures large, mid and small cap representation across 22 of 23 Developed Markets (DM) countries (excluding the United States) and 24 Emerging Markets (EM) countries. With 6,211 constituents, the index covers approximately 99% of the global equity opportunity set outside the US.
The MSCI Emerging Markets is designed to measure equity market performance in 25 emerging market indices. The index's three largest industries are materials, energy, and banks.
The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The Bloomberg Barclays 1-3 Month U.S. Treasury Bill Index includes all publicly issued zero-coupon U.S. Treasury Bills that have a remaining maturity of less than 3 months and more than 1 month, are rated investment grade, and have $250 million or more of outstanding face value. In addition, the securities must be denominated in U.S. dollars and must be fixed rate and non-convertible. The ICE U.S. Treasury 7-10 Year Bond Index is part of a series of indices intended to assess the U.S. Treasury market. The Index is market value weighted and is designed to measure the performance of U.S. dollar-denominated, fixed rate securities with minimum term to maturity greater than seven years and less than or equal to ten years. The ICE U.S. Treasury Bond Index Series has an inception date of December 31, 2015. Index history is available back to December 31, 2004.
The Barclays Capital Municipal Bond is an unmanaged index of all investment grade municipal securities with at least 1 year to maturity. The Bloomberg Barclays US Mortgage-Backed Securities (MBS) Index tracks agency mortgage backed pass-through securities (both fixed-rate and hybrid ARM) guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon and vintage. The Bloomberg Barclays U.S. Corporate High Yield Bond Index is composed of fixed rate, publicly issued, non-investment grade debt, is unmanaged, with dividends reinvested, and is not available for purchase. The index includes both corporate and non-corporate sectors. The corporate sectors are Industrial, Utility and Finance, which include both U.S. and non-U.S. corporations. The Bloomberg Barclays U.S. A Corporate Bond Index measures the investment-grade, fixed rate, taxable corporate bond market. It includes USD denominated securities publicly issued by US and non-US industrial, utility and financial issuers. Gold is subject to the special risks associated with investing in precious metals, including but not limited to: price may be subject to wide fluctuation; the market is relatively limited; the sources are concentrated in countries that have the potential for instability; and the market is unregulated. The LBMA Gold Price and LBMA Silver Price are the global benchmark prices for unallocated gold and silver delivered in London. SS&P GSCI Crude Oil is an index tracking changes in the spot price for crude oil. Investing in oil involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors.
One cannot invest directly in an index. Past Performance does not guarantee future results.
Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification. Investing in oil involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors. Bond prices and yields are subject to change based upon market conditions and availability. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility.