October 29, 2023 by Ethan Gilbert
Equities rallied through July in part thanks to corporate earnings that came in slightly better than expected. The market peaked on July 31st, at that time up 3.7% on the quarter and 18% for the year. Over the ensuing 3 weeks, markets fell 5.3% as longer-term interest rates rose by 0.40%. Stocks regained some ground through the middle of September before taking a nose-dive in the final weeks with dysfunction in Washington grabbing headlines and rates rising another 0.25% to 16-year highs.
The move in interest rates was mostly attributed to hawkish language coming from Jerome Powell and other members of the Federal Reserve. At some point in the future, the supply of bonds should be discussed more. With the Federal Government running near record deficits, and the Federal Reserve selling off assets, we’re issuing lots of new paper.
For some perspective, from 2013-2019, the amount of total U.S. outstanding bonds (Treasuries, Mortgage-backed, Corporates, Munis, Agencies, and other Asset-Backed) increased by $1.3 trillion/year. In 2023, The federal government is expected to run a $1.7 trillion deficit and the Federal Reserve is selling $1.1 trillion in assets.
Those two combined are more than double the average seen in pre-covid times over the last decade and it doesn’t count any additional net issuance from Mortgages, Corporates, Munis, Agencies, or other asset-backed issuers.
- Stocks fell across the board with U.S. and International sectors down between 3% and 5%.
- Bonds also sold off with the increase in interest rates. Long-duration bonds got killed with 30-year treasuries down 19%.
- Small-Cap Value stocks underperformed domestically, down 5.8% for the quarter. But internationally Small-Cap Value was one of the few asset classes to finish in the black, up 0.5%.
- Energy stocks were the biggest sector winner, gaining 13% as oil jumped 29%.
- REITs woes continue with the sector falling 7.1% in Q3. Another favorite “sector diversifier,” Utilities, dropped 9.4%.
- Bitcoin and gold fared poorly, declining 11.5% and 3.3% respectively.
- Housing prices rose 2.9% for the last three months we have data.
The situation in Israel with Hamas, the Gaza Strip, and Israel’s neighbors will be the most-watched news in the coming quarter. If the conflict ends quickly that will be a positive for markets. A war that spills into other parts of the region and disrupts oil markets will be the worst outcome for stocks. Continuing with the geopolitical theme, in Ukraine a war that has claimed 200,000 lives rages on with no end in sight. Again, the biggest economic impact from the war will probably be on energy prices.
Earnings season in the U.S. will be closely watched over the coming month. If companies can meet or exceed earnings expectations and issue forward guidance in line with previous estimates, the market should react positively.
The Fed will have our eyes as always. Officials have indicated another rate hike is likely, but the market isn’t buying it. We’ll see who is right, but the recent conflict in Israel has increased the odds of no more hikes.
Lastly, we’ll see the 2024 election getting increased attention. At the moment it looks like a rematch between Trump and Biden, with betting odds giving Trump a small edge due to recent polling in battleground states. A year is an eternity in politics, so the outcome is anyone’s guess. We also have another looming government shutdown battle as the house is currently without a speaker, and government funding runs out in 34 days.