Q3 2023 Market Perspective: Economic Resilience, Market Pullbacks, the Fed, and Israel

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The chaos of fall is here – the juxtaposition of back-to-school whirlwinds with the comfort of recurring rituals. As parents, the anticipation of growth and learning is as welcome as the early alarm clocks and bookbag pre-planning are dreaded. The good and the bad. The highs and lows. In financial planning, the constant tug of war across markets and data sources drives the way we track, process, and find perspective on the ongoing maintenance of your plan. Much like managing a new classroom, it’s impossible to control everything that happens in the world. But, like any savvy educator, our job is to distill information, provide pertinent perspective, and reinforce our approach to making progress.

Before we dive into the data and details, it’s important to address the wars in Ukraine and now Israel. Nearly two years into the Ukraine war, a notable geopolitical strategist recently stated “the war is over, but the fighting continues.” This statement embodies the notion that NATO is stronger and has succeeded in preventing a broader war in Europe. It’s just not over yet. The Israeli war launched after a surprise attack by Hamas is new fire in a long-burning conflict. We won’t speculate on the timing or involvement of other nations, because, regardless of further collusion, uncertainty will remain the outcome. In terms of broader macroeconomics, this changes very little today, though the geopolitical implications are obviously important. As always, discipline remains at a premium. Wars, conflicts, and geopolitical posturing are a part of our world. As investors, this is an unfortunate reminder of the unpredictability of world events and their impact on global markets.

On the economic front, all eyes remain on the Federal Reserve and the soft landing. As a reminder, the Fed has a dual mandate to control inflation and unemployment. Thus far, unemployment remains low at 3.8%, and inflation has dropped precipitously to the long run average. In many ways, 2023 is a year of economic normalization. That may be an unpopular stance, but when considering inflation, mortgage rates, GDP, the labor force, and yield curve changes, the economy is resilient and long run data shows a return to the mean.

Here are important considerations as we enter Q4:

The 3rd quarter broke a streak of three consecutive quarterly market increases.

• Emerging Market Stocks (MSCI Emerging Index): -2.79% Q3, 2.16% YTD
• U.S. Bonds (Bloomberg Barclays Aggregate Index): -3.23% Q3, -1.21% YTD
• U.S. Stocks (Russell 3000): -3.25% Q3, +12.39% YTD
• International Stocks (MSCI EAFE ): -4.05% Q3, +7.59% YTD
• U.S. Small Cap Stocks (Russell 2000): -5.13% Q3, +2.54% YTD

The third quarter was choppy, but consider that the Russell 3000 index returned 71.25% from 1/1/2018 through 9/30/2023. That time period includes a trade spat, COVID and the covid recession, the start of a war, an inflation spike, and three bear markets. Discipline is the key…

After a broader Q2 rebound, a mere seven companies have bolstered the stock market. While we prefer a broader rebound, this reminds us that diversification is about ensuring you have exposure to the winners. Imagine stock pickers who speculated on the other 493 companies in the S&P 500? They would not have participated in the rebound!

On average, a pullback of at least 10% every year is expected, even during a bull market. Consider that 53% of S&P 500(r) market days are positive and 47% of market days are negative, dating back nearly 100 years. The key is ensuring you’re around for all 53% of those days in spite of the other 47%. Missing out on one or two days in an attempt to predict the exact timing of market movement can collapse your financial outcome over time.

The third quarter was not a recessionary quarter. Q3 GDP is estimated by the Fed at a staggering 4.9%. While we open the news and see headlines and experts predicting recession, it continues to be pushed off in the future. That doesn’t mean there aren’t headwinds; the entire point of raising interest rates is to slow down transactions and incentivize citizens to hold money in the bank earning interest. But, 4.9% in Q3 is a far cry from contraction.

Inflation is 3.67% compared to a year ago. The average since 1960 is 3.77%, and the average since 1920 is 3.28%. Significant progress in moderating inflation has been made since the spike began in 2021. Inflation is at a long run normal rate, although we’d still prefer the Fed’s 2% target to become reality. The money supply is a more important indicator, and it’s down 3.67% since last year. This reduction is a leading indicator for inflation, and implies additional progress over the next twelve months should be expected.

Bonds are dominating headlines, but the headlines don’t tell the full story. Our country is woefully undereducated on bonds (AKA fixed income), so let’s reiterate some important concepts. During times of increasing interest rates, the most important metric is the maturity length. Longer maturity bonds lock investors into interest rates that suddenly are less attractive when the Fed raises the short term interest rate. As expected, the market prices of those longer term bonds drop accordingly. So while holding the bond until maturity will provide the holder with the full par value, the required practice of reflecting the current market price on statements is causing the news around bonds. Simply stated, if the bond price goes down 3%, but your income is fixed at 5% and you continue to collect the same interest payment, is the headline worthy? Bonds are supposed to be safer than equities, so pointing out a swift reduction in their price, without providing the full story, is an attempt to create clickbait.

A wise man once said, a financial plan is useless without discipline, diversification, and perspective. (that’s me…I wrote that!) History has repeatedly rewarded investors who maintained all of these. So, while the headlines may not always deliver positive updates, don’t make the mistake of changing your financial plan or investments because of them. Your family’s personal headlines are the reason to make changes, so as always, please reach out to us with any updates.

Sources: Ycharts, ATL Fednow, Fred.com

This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.

Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

Index Disclosures:

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.

Index Definitions:

The Consumer Price Index (CPI) is a measure of inflation compiled by the US Bureau of Labor Studies.

Barclays U.S. Aggregate Bond Index: The Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged index of fixed rate debt securities rated investment grade or higher by Moody’s, Standard & Poor’s, or Fitch rating services. All issues in the index have at least one year to maturity and an outstanding par value of at least $25 million to $1 billion based on the type of security. Indices are not available for direct investment and do not reflect any fees that may be charged.

S&P 500®: The S&P 500® index is an unmanaged index of 500 companies used as a representative sample of the United States economy. The S&P 500® index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.

MSCI EAFE: The MSCI Ex-US index is an unmanaged index used as a representative sample of the global developed economy outside of the United States and Canada. The MSCI EAFE index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.

MSCI Emerging Markets: The MSCI Emerging Market index is an unmanaged index used as a representative sample of the global emerging market economy outside of the United States. The MSCI Emerging Market index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.

The Russell 2000 index is an unmanaged index of the 2000 smallest companies in the Russell 3000 index. The Russell 2000 Index is used as a representative sample of the small companies in the United States economy. The Russell 2000 index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.

The Russell 3000 index is an unmanaged index of 3000 companies in the United States. The Russell 3000 Index is used as a representative sample of the United States economy. The Russell 3000 index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.