The list of things to cheer about for markets this year has been few compared to the large list of things that are worrying the markets. Despite all the risks the market has been facing, stocks have continued to climb the proverbial “wall of worry” this year. Technology stocks have been doing the heavy lifting with the strongest returns overall. However, stocks cooled off in August and September after their strong rally to begin the year. The selloff was driven by many of the same technology stocks that had the largest returns to begin the year.
Bonds had finally rallied to begin the year after two straight years of negative returns. They gave up the majority of those returns over the last quarter though as yields continued to rise. This is worrying markets that the Federal Reserve may hike rates one more time this year and keep rates higher for longer next year. Both worries would weigh on economic growth and tighten financial conditions, along with increasing the risk of a recession.
The US economy has proved very resilient so far in 2023. GDP growth has consistently come in above expectations all year alleviating the market’s fears that a recession was knocking on the door. It is yet to be seen if a recession will be able to be completely avoided with the Federal Reserve achieving a soft-landing, or if stronger GDP growth and consumer spending in 2023 just kicked the can down the road until 2024. The higher the Fed raises rates, the more strain it can put on the economy since Fed rate hikes work with a considerable lag. The Federal Reserve runs the risk of raising rates too high and holding them at elevated levels for too long, which eventually leads to overtightening resulting in a recession.
Federal Reserve policy will continue to be watched closely by markets, looking for signs of when the Fed will stop its rate hike cycle. The Fed has said they will keep rates at a higher level until they are sure that inflation is on a path to reaching their 2% target.
Recent inflation prints have been slightly higher than expected due to the increase in oil prices and shelter costs continuing to weigh heavily on inflation. However, interest rates have also increased over that period which works to tighten the economy. The Fed acknowledged that the recent increase in rates may be doing the work for them, and they are still undecided if they will hike again during their November or December meeting, saying they will be data dependent between now and then.
On the bright side, shelter inflation costs should start to move down through next summer which should alleviate some inflation pressure since shelter costs have been a large driver of overall inflation. We will continue to monitor the data to determine its impact on economic growth and inflation.
We continue to be mindful of the risks the market faces going forward from an aggressive Federal Reserve policy stance, including sticky areas of inflation remaining elevated, company earnings coming under pressure, and continued geo-political risks. We recommend staying the course with your investment objectives with the understanding that markets go through cycles and both the stock and bond market will eventually find their footing.
Please communicate with us if any short-term cash needs arise so we can look for opportunities to be proactive when raising cash for any necessary distributions, which helps to protect against possible short-term negative moves in the market. We appreciate the trust you’ve placed in us and will continue to make prudent investment decisions as we navigate the choppy markets.