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3 Reasons Investors Can Be Thankful This Holiday Season

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After a historic year, investors have much to be thankful for this holiday season. Despite periods of uncertainty around the Federal Reserve, the presidential election, and geopolitical conflicts, the stock market has delivered exceptional returns in 2024. With only a few weeks left in the year, the S&P 500 has gained 26.7% with dividends year-to-date, the Dow 19.5%, and the Nasdaq 27.4%. International stocks have also performed well, with emerging markets advancing 9.0% and developed markets 4.8%. Economic growth has exceeded expectations, with inflation returning to pre-pandemic levels, unemployment still low, and GDP growing steadily.

Financial markets have performed well this year

Just as many express gratitude in their personal lives, the holidays are a good time to do so in our investing and financial lives. This is important because investors tend to focus only on what can go wrong. Even after two strong market years, there is no shortage of concerns on issues such as market fundamentals, the direction of the economy, the size of the national debt, global instability, and more.

While past performance is no guarantee of future success, what history shows is that staying focused on the long run is the best way to achieve financial goals. Over the course of days, weeks and months, markets can fluctuate significantly just as they did in April and August, or in 2020 and 2022. However, over longer time horizons, markets have tended to rise due to the strength of economic growth. What can investors pause to appreciate this holiday season?


First, the U.S. stock market has demonstrated impressive strength in 2024. This is due to robust corporate earnings, better-than-expected economic conditions, and improving investor confidence. The accompanying chart shows that except for one quarter, the last two years have experienced steady market returns. While technology and AI stocks have led the way, many other sectors have contributed this year. In fact, most parts of the market are positive year-to-date, and eight of the eleven S&P 500 sectors have generated double-digit returns.


The strong bull market since the end of 2022 does mean that valuations are no longer as attractive. The price-to-earnings ratio for the S&P 500 is now 22.3, nearing both recent highs and the dot-com peak of 24.5.


Rather than a reason to avoid the stock market, stretched valuations are a reminder to hold a properly constructed portfolio. Owning stocks, or any risk asset, needs to be balanced with asset classes such as bonds to achieve portfolio goals. The end of the year is a perfect time to review your asset allocation, especially after this year’s market movements.


Inflation is returning to normal levels

Second, investors can be thankful that inflation rates have slowed to pre-pandemic levels. While this does not mean that prices will fall for most everyday necessities, including food and rent, it is a positive sign, nonetheless. This is especially true for investment portfolios since they are sensitive to interest rates, which are directly affected by inflation.


Normalizing inflation has allowed the Federal Reserve to begin cutting policy rates for the first time since early 2022. Much of this year’s stock market volatility was the result of investors guessing when and by how much the Fed would do so.


In the end, trying to determine the exact timing was far less important than understanding the general trend of lower short-term interest rates. Thus, for investors with long time horizons, constructing a portfolio based on these factors, rather than the trends that have driven markets over the past several years, is more important than ever.


The economy and job market remain strong

Finally, for everyday individuals, there is perhaps nothing more important from an economic standpoint than the strength of the job market. The fear as the Fed raised rates was that the economy would face a “hard landing” – i.e., bringing inflation down would cause a collapse in hiring.


Fortunately, this did not occur. Unemployment is still near historically low levels and job gains have been steady. Wages have also risen, although not as fast as overall inflation. The accompanying chart shows that the economy has created 28.6 million new jobs since the pandemic, far eclipsing the previous level. While job gains differ from sector to sector, this means that many consumers are in a healthy financial position.


More broadly, the U.S. economy continues to demonstrate remarkable resilience, with real GDP growing at an annualized rate of 2.8% in the most recent quarter. This is largely due to the strength of consumer spending, which has contributed greatly to overall growth. While this can’t last forever – consumers have largely spent their excess savings from the past few years and debt levels are rising – the hope is that lower rates, clarity around tax policy, and increased business investment will continue to support the economy.


The bottom line? Markets never move up in a straight line, and this year was no exception. Still, returns have been historically strong despite periods of volatility. This holiday season, investors should focus on the positives and ensure that their portfolios are aligned with their long-term financial goals.

3 Investor Lessons from the Summer’s Market Volatility

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As everyone settles into their post-Labor Day routines, it’s a good time for investors to reflect on markets and review their financial plans for the rest of the year. August began with the sharpest market declines in two years, but major indices have rebounded with the S&P 500 only a fraction of a percent from its all-time high. The Federal Reserve is widely expected to announce its first rate cut at its September 18 meeting, which has caused interest rates to stabilize in recent weeks. Inflation remains on a downward trajectory and the broader economy remains strong. So while September is beginning with additional market uncertainty, it’s important for investors to maintain perspective.

Markets have rebounded over the past month

Stock and Bond Annual Returns chart

In particular, investors should always be prepared for volatility, especially with possible market-moving events in the coming months. There is still uncertainty around the Fed’s full rate cut path, the upcoming presidential election, and ongoing geopolitical risks. What lessons can investors learn from the past few months as they navigate these events and focus on their long-term financial goals?


First, despite recent market swings, the S&P 500, Nasdaq, and Dow have gained 19.5%, 18.6%, and 11.7% with dividends this year, respectively. The S&P 500 has experienced only two periods of sustained pullbacks this year, with the largest decline measuring 8%, below the historical average. Bonds have struggled much of this year as rates remained high, but the anticipation of Fed rate cuts has helped to boost returns more recently. So while market volatility is never pleasant, it is important not to overreact to short-term events.


The stabilization in the stock market has shifted investor focus back to fundamental factors, particularly corporate earnings. This is because the stock market tends to mirror the trajectory of corporate profits over time, which in turn rises alongside the economy. Current earnings projections are positive with an expected growth rate of 10% in 2024 and nearly 14% over the next twelve months.

Similarly, bonds have performed better, with the Bloomberg U.S. Aggregate Index gaining 3.1% year-to-date and 6.7% since its bottom in April when the 10-year Treasury yield peaked around 4.7%. The high yield bond index has risen 6.3%, the corporate bond index 3.5%, and Treasurys 2.6%, fueled by the current Goldilocks period of improving inflation and steady economic growth. Bond prices also jumped at the beginning of August as they helped to balance stock market swings. These facts emphasize the importance of maintaining portfolio diversification, especially during periods of uncertainty.



The Fed is expected to cut rates in September

Federal Funds Rate chart

Second, the Fed is expected to begin cutting rates later this month after a rapid rate hike cycle from early 2022 to mid-2023. This is primarily because inflation has continued to improve. The Fed’s preferred inflation measure, the Personal Consumption Expenditures Price Index, has decelerated to 2.5% overall and 2.6% when excluding food and energy. Similarly, the headline Consumer Price Index has fallen to only 2.9% year-over-year with the core index declining to 3.2%. While prices are still much higher for consumers than prior to the pandemic, these improvements are enough for the Fed to justify a shift in monetary policy.


Much of the market volatility experienced this year is the result of changing expectations around the Fed. The year began with investors forecasting several rate cuts due to a possible “hard landing.” Then when inflation ran hotter than anticipated in the first quarter, investors believed there would be no rate cuts this year. Now, the Fed is expected to cut rates by about one percentage point through the end of the year. Each of these turns resulted in shifts in the market. This is yet another reminder that markets can get ahead of themselves, and that it’s often better to focus on the underlying trends.

In addition, recent jobs data show that the labor market is still strong but is also softening. The latest employment report, for instance, revealed that 114,000 new jobs were added in July, well short of the 175,000 projected. Unemployment rose from 4.1% to 4.3%, overshooting expectations and reaching a level not seen since the pandemic (though still not a historically high number). In a recent speech, Fed Chair Powell discussed the downside risks to the job market, saying “we do not seek or welcome further cooling in labor market conditions.” Whereas the Fed had been primarily focused on bringing down high inflation, it is now shifting its focus to the job market.

Interest rates are adjusting to a shift in Fed policy

Treasury Yield Curve chart

Finally, with Fed rate cuts approaching, market-based interest rates have adjusted as well. As the accompanying chart shows, not only have yields moved lower, especially on the short end of the curve, but the yield curve is no longer inverted. The spread between the 10-year and 2-year Treasury yields has flattened in recent days due to the expected trajectory of rates.

If these moves continue, they could have several potential implications for the economy and markets. One reason some investors expected a recession in 2024 was precisely because the yield curve experienced its sharpest inversion since the 1980s. Historically, yield curve inversions precede recessions since they typically occur later in the business cycle when the Fed has overtightened. While a recession is always possible, this time could be different since higher short-term yields were the result of inflation shocks.

While nothing is certain, lower rates could be positive for economic growth, especially in rate-sensitive areas such as real estate, technology, small caps, and more. As discussed earlier, bonds have benefited from improving rates as well, partially restoring their traditional role as portfolio diversifiers.

The bottom line? How we react to stock market swings is perhaps more important than the market moves themselves. The uncertainty experienced by investors during the summer is a reminder to always stay focused on the long run as they work toward their financial goals.

5 Insights for Long-Term Investors in the Second Half of 2024

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As we enter the second half of the year, it’s important for long-term investors to maintain perspective on the major events that drive markets. Despite ongoing economic uncertainty, the stock market has experienced a strong rally as investors anticipate the first Fed rate cut and the rally in artificial intelligence stocks continues. During the first six months of the year, the S&P 500 gained 15.3% with dividends, the Nasdaq 18.6%, and the Dow Jones Industrial Average 4.8%. The 10-year Treasury yield declined from its April peak of 4.7% to 4.4%, allowing the overall bond market to be roughly flat on the year. International stocks have performed better as well, with developed markets generating 5.7% and emerging markets 7.7%.



This strong performance may have caught some investors off guard while others may not have been properly positioned to take advantage of the upswing across many asset classes. This is because market sentiment can often turn on a dime, especially when there is so much investor and media focus on short-term events. For example, the recession that was anticipated at the beginning of the year has not yet occurred and there are signs that inflation, which ran hotter than expected for a few months, is beginning to improve.



Of course, the market’s focus will now shift toward major events in the second half of the year. Perhaps the most notable is the upcoming presidential election. As investors prepare to cast their ballots in November, they will also wonder what each political party could mean for their portfolios and financial plans. Investors will also watch the timing and number of Fed rate cuts closely since lower rates are generally positive for both stocks and bonds.

While the outcome of these events is uncertain and introduces new risks, the first half of the year is a reminder that overreacting to day-to-day headlines, at the expense of long-term underlying trends, can often result in poor investment decisions. History shows that it’s important to separate our personal feelings around politics from our financial decisions in order to stay invested, diversified, and disciplined. Below are five key facts all investors should keep in mind to stay levelheaded through the rest of 2024 and beyond.

1. The market continues to reach new all-time highs

On its way to a 15.3% gain in the first half of the year, the S&P 500 has achieved over 30 new all-time highs. While this is positive, it can also make many investors nervous. When the market is in uncharted territory, it’s easy to worry that it may be “due for a pullback.”



The reality is that price swings are an unavoidable part of investing and the market will certainly pull back at some point. However, the timing of these declines is difficult if not impossible to predict. At the same time, major stock market indices will naturally spend a significant amount of time near record levels during bull markets, as shown in the accompanying chart. Trying to time the market tends to be counterproductive for this reason.



This year, artificial intelligence stocks – particularly Nvidia – have contributed greatly to market returns with the Information Technology and Communication Services sectors gaining 28.2% and 26.7%, respectively. However, other sectors have more recently begun to benefit as well with Energy, Financials, Utilities, and Consumer Staples all experiencing rallies of around 10%. All told, 10 of the 11 sectors are positive on the year. While it’s unclear where large-cap technology stocks may go from here, staying diversified allows investors to benefit from a wide variety of sectors.

2. With inflation cooling, the Fed is on track to cut rates later this year

Investors have been anticipating the first rate cut of the cycle since the beginning of the year. This has not only driven returns, but is one reason markets have swung so much when new economic data has caused expectations to shift.



The accompanying chart shows the possible path of the federal funds rate based on the Fed’s latest projections. At its last meeting, the Fed cited strong job gains and low unemployment as indicators of solid economic activity but emphasized that “inflation has eased over the past year but remains elevated.” Fortunately, the latest inflation data in May showed a significant deceleration that has preserved the possibility of a rate cut this year.



Many of the additional rate cuts that investors previously expected have simply been pushed into next year and will depend on the economic data over the next six months. Regardless of the exact timing and path of Fed rate cuts, these projections represent a reversal of the emergency monetary policy actions that began in early 2022.

3. Steadier rates support the bond market

The path of interest rates has been highly uncertain over the past few years due to inflation, economic growth, and the Fed. Higher rates have defied the expectations of investors and economists, creating a challenging environment for the bond market, since rising rates push down bond prices.



After hotter-than-expected readings in the first quarter of the year, the latest Consumer Price Index data showed no change in overall prices in May for the first time in almost two years. Core CPI rose 0.2% in May, or 3.4% year-over-year, a healthy deceleration from the previous month’s 3.6% pace. Other data, such as the Personal Consumption Expenditures index that the Fed favors, and the Producer Price Index, have shown similar patterns.



These developments, along with new Fed guidance, have pushed rates lower in recent days, supporting bond prices. The Bloomberg U.S. Aggregate Bond Index, a measure of the overall bond market, is nearly flat on the year after declining as much as 4% in April. This is in sharp contrast to 2022 when bonds fell into a bear market during the historic jump in interest rates, before stabilizing and rebounding in 2023.

4. Many investors remain on the sidelines in cash

In times of market uncertainty, investors often seek the safety of cash. This has been true over the past several years as markets have swung due to the pandemic, geopolitical events, Fed rate hikes, inflation, gridlock in Washington, technology trends, and more. Additionally, interest rates on cash are at their highest levels in decades, making it appear that there are attractive “risk-free” returns.



While cash is important, it can become problematic when investors hold too much cash. This is because cash is not truly risk-free for two important reasons. First, inflation quietly erodes the purchasing power of cash over time. So even if yields appear to be high, the real value of your money could decline.



Second, the prospects for cash will only worsen if and when the Fed does begin to cut rates. Investors would be forced to reinvest their cash either at lower interest rates or in stocks and bonds whose prices would most likely have already risen.

5. The presidential election is heating up

Coverage of the presidential election is heating up. While elections are an essential way for Americans to help shape the direction of the country as citizens, voters and taxpayers, it’s important to vote at the ballot box and not with investment portfolios.



History shows that markets can perform well under both major political parties. As the accompanying chart shows, the economy and stock market have grown over decades regardless of who was in the White House. What mattered more across these periods were the ups and downs of the business cycle.



Of course, politics can impact taxes, trade, industrial activity, regulations, and more. However, not only do policy changes tend to be incremental, but also the exact timing and effects are often overestimated. Thus, it’s important to focus less on day-to-day election poll results and more on the long-term economic and market trends. Ideally, investors concerned about the impact of specific policies on their financial plans should speak with a trusted financial advisor.



The bottom line? Investors should keep these five factors in mind as we head into summer. As always, it’s important to maintain a long-term perspective to achieve investing goals. Working with a trusted financial advisor can help you navigate through an uncertain future and be prepared for changes in the economy and stock market through the rest of 2024.

Some Investors Think Trading Around Election Outcomes Makes Sense

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Some investors think trading around election outcomes makes sense. Covering the modern period for the S&P 500, investing only when a Republican was in the White House, a $10K initial investment in 1961 would have grown to more than $102K by 2023. On the other hand, the same $10K initial investment would have grown to more than $500K, investing only when a Democrat was in the White House. Some might stop the analysis there and conclude that staying out under Republican presidents and being in under Democratic presidents is a winning strategy.

But the real moral of the story is told with the final bar. The same $10K initially invested in 1961 would have grown to more than $5.1M by just staying invested, without regard for the political party in power.

Source: Schwab Center for Financial Research with data provided by Morningstar, Inc.

2023 Market and Economic Review

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Market and Economic Chartbook | February 1, 2024

Stocks and Bond Annual Returns graph
  • Stocks and bonds have both struggled recently due to rising inflation and interest rates.
  • This breaks the historical pattern driven by falling bond yields which supported bond prices.
  • Despite this challenging period, investors should continue to focus on diversification as interest rates stabilize.
U.S. Business Cycles graph
  • The economy slowed due to inflation and Fed tightening but the recession some anticipated has not materialized.
  • Growth has been remarkably steady despite what many economists had feared.
Unemployment Rates graph
  • Unemployment is still near the lowest in over 50 years despite rising rates and broader economic challenges.
  • Even the so-called under-employment rate has fallen to near-historic lows as jobs remain plentiful.
  • The labor market remains strong despite higher rates, resulting in what many investors refer to as a so-called soft landing.
Consumer Price Index graph
  • CPI is a commonly cited measure of inflation. It uses a basket of goods and services to track price changes for consumers.
  • In order to measure the underlying trend in inflation, rather than temporary shocks to food and energy economists often focus on core CPI.
  • Price increases have been cooling but certain areas such as shelter remain high.
Treasury Yield Curve graph
  • The yield curve is still inverted due to the elevated level of Fed policy rates.
  • The yield curve could begin to re-steepen as the Fed begins to cut rates in 2024.
  • Long-term rates could also remain high or rise further if economic growth remains steady.
Global Central Bank Balance Sheets
  • Major central banks raised rates over the past two years to fight inflation, causing growth to slow.
  • Balance sheets are also beginning to run down which could eventually push longer-term rates higher.
Global Equity Valuations graph
  • Major stock market indices have taken very different trajectories over the past decade due to differences in growth.
  • U.S. market valuations are elevated compared to other regions as it continues to outperform.
  • International stocks, on the hand, are still cheaper in relative terms across both the developed and emerging world.
Global Earnings and Valuations graph
  • Earnings growth and valuations are two important metrics when comparing regions and asset classes.
  • The U.S. market is the most expensive due to its strong performance this year.
  • Other international markets are still cheaper, especially emerging markets.
Developed Market Recent Performance graph
  • Developed markets have trailed U.S. markets for over a decade despite improvements in some of their fundamentals.
  • Over the past few years, these regions have struggled due to the pandemic, inflation, rising rates and geopolitical risks.
Asset Classes Relative to U.S. Stocks graph
  • The significant outperformance of U.S. stocks in prior years had led some investors to avoid other asset classes.
  • There have been many historical periods when other asset classes outperformed. Diversification takes advantage of these trends.
  • With cheaper valuations and global growth, it may be best to not overlook other regions.
Stocks and Geopolitical Events graph

Definitions and Methodology

The S&P 500 is a market capitalization-weighted index of large
cap U.S. stocks. U.S. mid cap and small cap are the S&P 400 and S&P 600, respectively. Value and growth are the corresponding Standard and Poor’s value and growth indices.

MSCI EM is and index of emerging market stocks. MSCI EAFE is an index of developed market stocks. MSCI ACWI is an index of global stocks.

The forward P/E is a ration of the current market price of an index divided by an estimate of earnings over the next twelve months. The Shiller P/E is based on Robert Shiller’s cyclically adjusted price-to-earnings ration.

The AAII Investor Sentiment index is based on a weekly survey conducted by AAII.

Unless stated otherwise, earnings and valuations data are from LSEG indices.

The LEI, or Leading Economic Index, is produced monthly by the Conference Board.

Consumer sentiment indices are based on surveys conducted by the University of Michigan Surveys of Consumers.

Asset Class Performance and Asset Classes Relative to U.S. Stocks charts: The EM, EAFE, Small Cap, Fixed Income and Commodities are these indices, respectively: MSCI EM, MSCI EAFE, Russell 2000, iShares Core U.S. Bond Aggregate, Bloomberg Commodity Index.

Fixed Income Performance: All sectors are represented by the Bloomberg Barclays bond indices except for EMD USD and Local which are JPMorgan EMBIG Diversified Index and JPMorgan GBI-EM Core Index, respectively.

The Balanced Portfolio is a hypothetical 60/40 portfolio consisting of 40% U.S. Large Cap, 5% Small Cap, 10% International Developed Equities, 5% Emerging Market Equities, 35% U.S. Bonds, and 5% Commodities.

The Bloomberg Commodity Index is a broadly diversified basket of physical commodities futures contracts.

The DXY is a U.S. dollar index based on a basket of currencies, including the Euro, Yen, Pound, Canadian Dollar, Swedish Krona and Swiss Franc.

Portfolio Risk/Reward and Portfolio Drift Since 2009 charts: stocks and bonds are the S&P 500 and iShares Core U.S. Bond Aggregate, respectively. Each portfolio represents a hypothetical stock/bond asset allocation.

The MSCI Factor indices are created and maintained by MSCI to capture factor returns. They cover various factors including Quality, Size, Momentum, Volatility, Value and Yield. The Multi-Factor index tracks the performance of Value, Momentum, Quality and Size.

The MSCI USA index tracks large and mid cap U.S. stocks.

Clearnomics Disclosures

Copyright (c) 2024 Clearnomics, Inc. All rights reserved. The information contained herein has been obtained from sources believed to be reliable, but is not necessarily complete and its accuracy cannot be guaranteed. No representation or warranty, express of implied, is made as to the fairness, accuracy, completeness, or correctness of the information and opinions contained herein. The views and the other information provided are subject to change without notice. All reports posted on or via www.clearnomics.com or any affiliated websites, applications, or services are issued without regard to the specific investment objectives, financial situation, or particular needs of any specific recipient and are not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. Company fundamentals and earnings may be mentioned occasionally, but should not be construed as a recommendation to buy, sell, or hold the company’s stock. Predictions, forecasts, and estimates for any and all markets should not be construed as recommendations to buy, sell, or hold any security—including mutual funds, futures contracts, and exchange traded funds, or any similar instruments. The text, images, and other materials contained or displayed in this report are proprietary to Clearnomics, Inc. and constitute valuable intellectual property. All unauthorized reproduction or other use of material from Clearnomics, Inc. shall be deemed willful infringement(s) of this copyright and other proprietary and intellectual property rights, including but not limited to, rights of privacy. Clearnomics, Inc. expressly reserves all rights in connection with its intellectual property, including without limitation the right to block the transfer of its products and services and/or to track usage thereof, through electronic tracking technology, and all other lawful means, now known or hereafter devised. Clearnomics, Inc. reserves the right, without further notice, to pursue to the fullest extent allowed by the law any and all criminal and civil remedies for the violation of its rights.

Quarterly Insights – October 2023

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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 IndexesQ3 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 IndexesQ3 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 IndexesQ3 Return YTD
S&P GSCI (Broad-Based Commodities)17.06%7.24%
S&P GSCI Crude Oil29.85%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 IndexesQ3 Return YTD
BBgBarc US Agg Bond-2.94%-1.21%
BbgBarc US T-Bill 1-3 Mon1.36%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 Yield0.80%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, I remain vigilant towards economic and market risks and remain focused on managing both risk and return potential. I remain a firm believer 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.

Quarterly Insights – July 2023

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Declining Inflation and Resilient Growth Push Stocks Higher in Q2

The S&P 500 ended the second quarter and first half of 2023 at a 14-month high and most major stock indices logged solid gains in the second quarter following a pause in the Fed’s rate hike campaign, stronger-than-expected corporate earnings (especially in the tech sector) and the relatively drama-free resolution of the debt ceiling.

The second quarter began with markets still in the throes of the regional bank crisis following the March failures of Silicon Valley Bank and Signature Bank, and investors started the month of April wary of contagion risks. Those concerns proved mostly overdone, however, as throughout most of the month regional banks were stable. That stability allowed investors to re-focus on corporate earnings, and the results were much better than feared as 78% of S&P 500 companies reported better-than-expected Q1 earnings, a number solidly above the 66% long-term average. Additionally, 75% of reporting companies beat revenue estimates for the first quarter, also well above the long-term average. That solid corporate performance was a welcome sight for investors and coupled with general macroeconomic calm, allowed stocks to drift steadily higher throughout most of April. However, following an underwhelming earnings report, concerns about the solvency of First Republic Bank weighed on markets late in the month and the S&P 500 declined into the end of April to finish with a modest gain.

Fears of a First Republic Bank failure were realized on May 1st, as the bank was seized by regulators and the FDIC was appointed its receiver. However, that same day, JPMorgan announced it was acquiring the bank from the FDIC, and that move helped to calm investor anxiety about financial contagion risks. The Federal Reserve also helped to distract investors from the First Republic failure, as the Fed hiked rates at the May 2nd FOMC meeting, but importantly altered language in the statement to imply it would pause rate hikes at the next meeting. That change was expected by investors, however, and as such it failed to ignite a meaningful rally in stocks. Instead, the tech sector helped push the S&P 500 higher in mid-May, thanks to an explosion of investor and financial media enthusiasm around Artificial Intelligence (AI), which was highlighted by a massive rally in Nvidia (NVDA) following a strong earnings report. However, like in April, the end of the month saw an increase in volatility. This time it was thanks to the lack of progress on a U.S. debt ceiling extension and rising fears of a debt ceiling breach and possible U.S. debt default. However, a two-year debt ceiling extension was agreed to by Speaker McCarthy and President Biden on May 28th and was signed into law a few days later, avoiding a financial calamity. The S&P 500 finished May with a slight gain.

With the debt ceiling resolved, a Fed pause in rate hikes expected and continued stability in regional banks, the rally in stocks resumed in early June and was aided by several potentially positive developments. First, inflation declined as the Consumer Price Index (CPI) hit the lowest level in two years. Second, economic data remained impressively resilient, reducing fears of a near-term recession. Finally, in mid-June, the Federal Reserve confirmed market expectations by pausing rate hikes and that helped fuel a broad rally in stocks that saw the S&P 500 move through 4,400 and hit the highest levels since April 2022. The last two weeks of the month saw some consolidation of that rally thanks to mixed economic data, political turmoil in Russia and hawkish rhetoric from global central bankers, but the S&P 500 still finished June with strong gains.

In sum, markets were impressively resilient in the second quarter and throughout the first half of 2023, as better-than-feared earnings, expectations for less-aggressive central bank rate hikes, more evidence of a “soft” economic landing and relative stability in the regional banks pushed the S&P 500 to a 14-month high.    

Second Quarter Performance Review

The second quarter of 2023 saw an acceleration of the tech sector outperformance witnessed in the first quarter, as “AI” enthusiasm drove several mega-cap tech stocks sharply higher. Those strong gains resulted in large rallies in the tech-focused Nasdaq and, to a lesser extent, the S&P 500 as the tech sector is the largest weighted sector in that index. Also like in the first quarter, the less-tech-focused Russell 2000 and Dow Industrials logged more modest, but still solidly positive, quarterly returns. 

By market capitalization, large caps outperformed small caps, as they did in the first quarter of 2023. Regional bank concerns and higher interest rates still weighed on small caps as smaller companies are historically more dependent on financing to maintain operations and fuel growth.

From an investment style standpoint, growth handily outperformed value again in the second quarter, continuing the sharp reversal from 2022. Tech-heavy growth funds benefited from the aforementioned “AI” enthusiasm. Value funds, which have larger weightings towards financials and industrials, relatively underperformed growth funds, as the performance of non-tech sectors more reflected the broad economic reality of mostly stable, but unspectacular, economic growth.

On a sector level, eight of the 11 S&P 500 sectors finished the second quarter with positive returns. As was the case in the first quarter, the Consumer Discretionary, Technology, and Communication Services sectors were the best performers for the quarter. The surge in many mega-cap tech stocks such as Amazon (AMZN), Apple (AAPL), Alphabet (GOOGL), Meta Platforms (META), and Nvidia (NVDA) drove the gains in those three sectors, and they handily outperformed the remaining eight S&P 500 sectors. Industrials, Financials, and Materials saw moderate gains over the past three months, thanks to rising optimism regarding a “soft” economic landing.  

Turning to the laggards, traditional defensive sectors such as Consumer Staples and Utilities declined slightly over the past three months, as resilient economic data caused investors to rotate to sectors that would benefit from stronger than expected economic growth.  Energy also posted a slightly negative return for the second quarter, thanks to weakness in oil prices. 

US Equity IndexesQ2 Return YTD
S&P 50010.32%16.89%
DJ Industrial Average5.28%4.94%
NASDAQ 100 17.33%39.35%
S&P MidCap 4006.70%8.84%
Russell 20007.24%8.09%
Source: YCharts

Internationally, foreign markets lagged the S&P 500 thanks mostly to the relative lack of large-cap “AI” exposed stocks in major foreign indices, combined with some late-quarter worries about the EU economy and pace of Bank of England rate hikes, although foreign markets did finish the second quarter with a modestly positive return. Foreign developed markets outperformed emerging markets thanks to a lack of significant economic stimulus in China, which weighed on emerging markets late in the quarter.  

International Equity IndexesQ2 Return YTD
MSCI EAFE TR USD (Foreign Developed)3.63%12.13%
MSCI EM TR USD (Emerging Markets)1.50%5.10%
MSCI ACWI Ex USA TR USD (Foreign Dev & EM)3.13%9.86%
Source: YCharts

Commodities saw modest losses in the second quarter as most major commodities declined over the past three months. Oil prices witnessed a moderate drop despite a surprise production cut from Saudi Arabia and an increase in geopolitical tensions in Russia, as concerns about future economic growth and oversupply weighed on oil. Gold, meanwhile, posted a modestly negative return as inflation declined while the dollar failed to meaningfully drop.  

Commodity IndexesQ2 Return YTD
S&P GSCI (Broad-Based Commodities)-1.45%-7.54%
S&P GSCI Crude Oil-5.21%-12.40%
GLD Gold Price-3.08%5.23%
Source: YCharts/Koyfin.com

Switching to fixed-income markets, the leading benchmark for bonds (Bloomberg Barclays US Aggregate Bond Index) realized a slightly negative return for the second quarter of 2023, as the resilient economy and hope of a near-term end to Fed rate hikes led investors to embrace riskier assets.   

Looking deeper into the fixed-income markets, shorter-duration bonds outperformed those with longer durations in the second quarter, as bond investors priced in a near-term end to the Fed’s rate hike campaign, while optimism regarding economic growth caused investors to rotate out of the safety of longer-dated fixed income.

Turning to the corporate bond market, lower-quality, but higher-yielding “junk” bonds rose modestly in the second quarter while higher-rated, investment-grade debt logged only a slight gain. That performance gap reflected investor optimism on the economy, which led to taking more risk in exchange for a higher return.  

US Bond IndexesQ2 Return YTD
BBgBarc US Agg Bond-0.38%2.09%
BBgBarc US T-Bill 1-3 Mon1.23%2.33%
ICE US T-Bond 7-10 Year-1.32%1.62%
BBgBarc US MBS (Mortgage-backed)-0.41%1.87%
BBgBarc Municipal0.04%2.67%
BBgBarc US Corporate Invest Grade0.40%3.21%
BBgBarc US Corporate High Yield2.60%5.38%
Source: YCharts

Third Quarter Market Outlook

As we begin the third quarter of 2023, the outlook for stocks and bonds is arguably the most positive it’s been since late 2021, as inflation hit a two-year low, economic growth and the labor market remain impressively resilient, the Fed has temporarily paused its historic rate hiking campaign, the debt ceiling extension is resolved, and we’ve seen no significant contagion from the regional bank failures from earlier this year.

That improvement in the fundamental outlook has been reflected in both stock and bond prices so far this year, as the S&P 500 hit the best levels since last April and more cyclically focused sectors led markets higher late in the quarter on rising hopes for a broad economic expansion.  

However, while clearly the past quarter brought positive developments in the economy and the markets, leading the financial media to proclaim a “new bull market” has started, it’s important to remember that potentially significant risks remain to the economy and markets. Put more bluntly, the market has taken a decidedly positive view on the ultimate resolution of multiple macroeconomic unknowns, but their outcomes remain very uncertain and thanks to the strong year-to-date rally in stocks, there is now little room for disappointment.

First, the economy has not yet felt the full impact of the Fed’s historically aggressive hike campaign, and while the economy has proved surprisingly resilient so far, we know from history that the impacts of rate hikes can take far longer than most expect to impact economic growth. Put in plain language, it’s premature to think the economy is “in the clear” from recession risks, and we should all expect the economy to slow more as we move into the second half of 2023. The key for markets will be the intensity of that slowing, as at these valuation levels stocks are not pricing in a significant economic slowdown.  

On inflation, clearly there’s been progress in bringing inflation down, as year-over-year CPI has fallen from over 9% in 2022 to 4% in less than a year’s time. However, even at 4%, CPI remains far above the Fed’s 2% target. If inflation bounces back, or fails to continue to decline, then the Fed could easily hike rates further, like the Bank of Canada and Reserve Bank of Australia did in the second quarter, following pauses of their own. Those higher rates would weigh further on economic growth.  

Turning to banks, markets have taken the regional bank failures in stride, as the collapse of First Republic Bank caused minimal volatility in the second quarter. However, it’s likely premature to consider the crisis “over” and at a minimum, reduced lending by regional banks poses an additional threat to the commercial real estate market and small businesses more broadly. Bottom line, measures taken by the Fed in March have “ringfenced” the regional bank stress for now, but this remains a risk to the economy.

Finally, markets are trading at their highest valuation in over a year, and investor sentiment has turned suddenly, and intensely, optimistic. The CNN Fear/Greed Index ended the second quarter at “Extreme Greed” levels, while the American Association for Individual Investors (AAII) Bullish/Bearish Sentiment Index hit the most bullish level since November 2021, right before the market collapse started in early 2022. Positive sentiment does not automatically mean markets will decline, but the sudden burst of enthusiasm needs to be considered in the context of what is a still uncertain macroeconomic environment and markets no longer have the protection of low expectations and valuations to cushion declines.  

In sum, clearly there have been positive macro developments so far in 2023 that have helped the stock market rebound. However, it’s important to remember that multiple and varied risks remain for the economy and markets.  

What the Fed’s Hawkish Pause Means for Long-Term Investors

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At its June meeting, the Fed decided to hit pause on rate hikes after more than a year of rapid monetary policy tightening. Since last March, the Fed has raised rates 10 times from zero to 5%, making this the second-fastest rate hike cycle in history. However, some consider the Fed’s latest decision to be a “hawkish pause” since policymakers have penciled in two additional rate hikes later this year. With interest rates expected to remain higher for longer, what do long-term investors need to know to stay focused on their financial goals?

The Fed expects to raise rates again after skipping June

Federal Funds Rate graph

Perhaps the simplest way to understand the Fed’s latest move is that it is consistent with a slower pace of rate hikes, rather than a complete shift in policy. Since last December, the Fed has steadily decreased the size of each rate hike from 75 basis points (i.e., 0.75%), to 50 bps, to 25 bps, and now possibly to 25 bps every other meeting. At his latest press conference, Fed Chair Powell even inadvertently referred to the June decision as a “skip,” which implies they could raise again in July.

The Fed believes it is reaching a level of interest rates that is restrictive enough to slow inflation. Last week’s Consumer Price Index report, for instance, shows that overall inflation has decelerated to “only” 4% on a year-over-year basis, a significant improvement from the 9.1% pace experienced a year ago. Over this period, gasoline prices have fallen 19.7%, overall energy prices by 11.7%, and the prices of used cars and trucks have declined 4.2%. Other measures of inflation such as the Producer Price Index, also released last week, have made even more progress with the headline index rising only 1.1% year-over-year.

Why might the Fed keep rates high if inflation is already improving? The real challenge facing policymakers continues to be “core inflation,” a concept that excludes food and energy prices to better understand underlying inflation trends. From an economic perspective, inflation that is “sticky” or that threatens an inflationary spiral – i.e., when higher prices result in higher wages, which in turn result in more spending and even higher prices – is the real culprit. Since this depends on the behavior and activities of businesses and consumers, it will take time to improve.

Consumer prices are rising at a slower pace but core inflation remains a problem

Consumer Price Index Components graph

For example, core inflation rose 5.3% in May compared to a year earlier – an improvement from its peak of 6.6% last September but still well above the Fed’s target. The main driver is the cost of housing, referred to as “Shelter” in the CPI report, which has increased 8% over this period and represents a third of the CPI index. Shelter consists of rent payments and what is known as “owners’ equivalent rent,” or what a homeowner would pay to rent their property. While there are signs and hopes that shelter costs will decelerate as leases are renewed, this might only slowly appear in the inflation data. Excluding shelter from core inflation, prices have risen 3.4%.

Of course, higher rates have slowed some parts of the economy, most notably in the financial and real estate sectors. Fortunately, the banking crisis that began in March appears to be stable for the time being, and has arguably benefited banks with strong balance sheets. The jump in the Fed’s own balance sheet in the aftermath of Silicon Valley Bank’s collapse, due to programs such as the Bank Term Funding Program, has already reversed. Residential real estate continues to struggle with the average 30-year fixed mortgage rate around 7%, but there are some signs that housing activity, including existing home sales, is stabilizing. Commercial real estate remains the biggest wildcard as refinancing uncertainty continues.

In contrast, many parts of the economy remain unusually strong given the level of policy rates, allowing the Fed to continue raising at a slower pace. Unemployment is still exceptionally low and the FOMC’s latest projections show that they expect it to rise to only 4.1% by year end. The stock market has also taken recent events in stride with the S&P 500 climbing 15% this year, driven largely by technology stocks. The index has risen 23% since the bottom last fall and is now only 8% below its all-time high achieved at the beginning of 2022.

Global policy rates remain high after a year of tightening

Global Central Bank Policy Rates

It’s worth noting that not all central banks are following the Fed’s lead. For instance, the European Central Bank decided to raise rates just a day after the Fed’s decision to pause. Unlike in the U.S. where economic growth has remained surprisingly robust and inflation has slowed, Europe is experiencing a recession after two quarters of negative growth. Eurozone inflation remains stubbornly high with the headline and core measures rising 6.1% and 6.9% year-over-year in May, respectively. Similarly, the Bank of England’s Bank Rate is currently 4.5% but markets expect a peak rate of 5.5%.

The bottom line? The Fed skipped a rate hike in June due to improving inflation but could raise rates again later this year. Either way, rates will likely remain higher for longer, especially as other central banks continue to tighten policy. Investors should continue to focus on their long-term financial goals as Fed policy evolves.

All written content is for information purposes only. Opinions expressed therein are solely those of Patricia Jennerjohn, Managing Partner, Focused Finances LLC. Material presented is believed to be from reliable resources and no representations are made as to its accuracy or completeness. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. Fee only financial planning and investment advisory services are offered through Focused Finances LLC, a registered investment advisory firm in the state of California.

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