A Seasonal Chill
3Q 2023
The economy remained resilient during the third quarter, prompting some excitement that the Federal Reserve (the Fed) could engineer a soft-landing for the U.S. economy. Payroll numbers remained solid, unemployment stayed low, GDP data was positive, and inflation continued its downward path. The financial markets, however, gave back some of the gains seen in the first two quarters as investors struggled to digest the idea of higher interest rates for longer, while union strikes and Congressional turmoil also weighed on sentiment. Large cap U.S. stocks and core U.S. bonds were both down a little over 3% for the quarter[1].
While we do not put too much weight on monthly averages, September has historically been the worst month for the stock market, with the S&P 500 declining 0.8% since 1950 (followed by January, which averages a little more than -0.1%). For what it is worth, the following four months then average a positive return above 0.8%.[2] The market does seem right to worry about rates being higher for longer, but hopefully the worst of the bond market selloff is behind us with inflation cooling and yields getting closer to the Fed’s projections. If rates do stay higher for longer, the worst may still be ahead for the U.S. economy despite the positive economic data mentioned above. Higher rates are meant to constrain consumer and business consumption and more cracks are beginning to show.
While consumer spending has continued rising, it appears to finally be tapped out with credit card balances at record highs. The San Francisco Fed estimated that a total of $2.1 trillion more than expected was saved during the COVID years due to government transfer payments, but the last couple of years has seen $1.9 trillion in excess spending erode those stockpiles. Anecdotally, we have heard more frequent mentions of slowing businesses and personal spending cuts.
The average 30-year fixed mortgage rate hit 7.5% last week, the highest they have been since 2000 according to Freddie Mac. This has made housing affordability rates plummet, causing demand to slow. At the same time, supply is also slowing as homeowners are reluctant to give up their current mortgages locked-in during the years of low interest rates. This interesting dynamic has kept housing prices elevated and limits any real impact on the broader economy.
There are other bright spots that still provide some hope for at least a shallow recession, if not quite a soft landing. Core inflation (excluding food and energy) has continued to come down, and employment numbers remain strong. In September, the unemployment level remained unchanged at 3.8% and payrolls doubled estimates with 336,000 new jobs, with the prior two months being revised upward by 119,000. Average weekly wages grew 3.5% year-over-year, finally outpacing inflation.[3]
We expect market volatility to remain a near-term constant as investors try to figure out the Fed’s likely path with interest rates, but a recession still appears unlikely to begin this year. Staying invested and rebalancing when appropriate should be every investor’s focus. If an investor invested $1 million in a 60% stock/40% bond portfolio on January 1, 2022, they would have lost about 20% at the bottom of the market in October 2022. If they stayed invested, they would have recovered to about $892,000 at the end of September 2023, but if they moved to cash, they would only have about $831,000 – a $61,000 difference.[4] While cash may seem to offer a warm hug, staying invested can get you to a better place over time, despite the occasional seasonal chill.
[1] Source: Bureau of Labor Statistics
[2] Source: Vanguard
[3] As represented by the S&P 500 Index and the Barclays U.S. Aggregate Index. Investors cannot directly invest in an index. Source: Morningstar Direct.
[4] Source: Morningstar Direct, Brand AMG