Wealth Matters Newsletter - October 2023

A Season Of Change

Written by: Mark P. Bernier, CFA, Senior Vice President/Wealth Management Officer

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 The transition from summer to fall is dynamic.  It’s almost as though there is a tug-of-war between the seasons:  summer-like one day, frost warnings the next.  Markets offered similar dynamics during the third quarter, as investors contended with stock markets that began the quarter on an upward trajectory, only to be met with another quarterly earnings decline in the S&P 500, continued uncertainty about direction and duration of the U.S. Federal Reserve’s monetary policy, and a last-minute deal to avoid a government shutdown.  It is likely that interest rate volatility will be a primary driver of markets and investor behaviors for the foreseeable future, though corporate earnings – particularly from the financial, consumer staples, consumer discretionary, and technology sectors – will provide plenty of cross currents for investors to navigate.

Earnings
Third-quarter earnings for S&P 500 companies are anticipated to drop by 0.3% year-over-year, according to consensus estimates published in a recent report from FactSet.  If earnings decline for the quarter, that will mark four consecutive quarters of year-over-year earnings declines for index companies, and truly reflective of an “earnings recession”.  Bear in mind, earnings reports are a look in the rear-view mirror, so we’ll be closely listening to the tone of any earnings guidance for the fourth quarter and 2024.  

Markets have been resilient this year despite weaker earnings and higher interest rates, resulting in higher valuations (particularly in U.S. large capitalization stocks).  At the end of the third quarter 2023, the S&P 500 provided a 13.07% total return, year-to-date.  Much of that return in the index can be attributed to the seven largest stocks in the index: Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla.  The year-to-date return of an equal-weighted S&P 500 index (each company receives the same percentage weight, rather than weighted by company size) falls to 1.79% as of September 30.  This large variance indicates the market’s returns lack breadth or participation from a greater number of companies; this could also indicate market returns that are potentially fragile due to their dependence on the performance of a limited number of stocks.  High interest rates have historically been a headwind for stock performance and we believe that the current interest rate environment is likely to stay with us for some time.

Interest Rates
U.S. Treasury yields made a substantial move higher during the quarter, particularly longer maturity Treasury instruments.  

The jump in longer term yields can be primarily attributed to investors’ belief that higher yields will be with us for longer, thus requiring a greater premium (known as term premium) for investing in longer-date maturities.  This term structure more closely matches the Federal Reserve’s Fed Funds forecast that was released at its September Federal Open Market Committee meeting, which indicates the Fed Funds rate holding at 5.5% this year and remaining at 5% or higher in 2024.  Obviously, this forecast is highly dependent on inflation and the speed with which it subsides. Though bond performance has been weak so far in 2023, the move up in yields is providing an opportunity to lock in higher-yielding, higher quality fixed income investments, in our opinion.  With the potential for yields to move lower over the next several years, as indicated by the shape of the yield curve, investors may be rewarded for investing in longer-dated maturities. As a reminder, interest rates and bond prices move in opposite directions (all other factors held constant), and longer maturity bonds tend to have more price sensitivity to interest rate movements than shorter maturity bonds.

As investors assess the challenges facing the stock markets and potential opportunities in the bond markets, we would expect some volatility for the balance of the year.  

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