Market Memo | October 2023

October provided mostly tricks, with a hint of treats toward the close of the month.

After declining to start the month, the S&P 500 index began making gains mid-month, but ultimately ended the month down 2.10%. Bonds fared a little better with the Bloomberg US Aggregate Bond index finishing down 1.58%. While the equity market performance could be chalked up to the outbreak of war in the Middle East, the bond market serves as a safe haven with positive returns in times of stress. Looking under the surface, the massive issuance of debt by the U.S. Treasury sent bond yields higher and the principal value of bonds lower. Twice during the month, the 10-year Treasury bond reached or exceeded 5%, a rate that has not been seen since 2007. If investors were concerned about geopolitical issues, they did not turn to the U.S. Treasury for refuge.

The 10-year Treasury is a key interest rate in the U.S. economy.

While the Federal Reserve (Fed) controls the short-term interest rate, the market determines the 10-year rate. The 10-year rate has direct correlation to mortgages, auto loans, and student loans. The impact of a rise in this key rate tends to work through the economy quicker than the short-term rates set by the Fed. When rates go up, bonds and stocks tend to go down in price.

Since the Great Financial Crisis of 2008, the Fed has added tools to influence or directly target longer term rates, typically by buying and selling longer term bonds. While these tools kept rates low, it also encouraged massive borrowing. Treasury Secretary Janet Yellen doesn’t speak about shrinking the debt, but rather the capacity to service the debt. Servicing the debt, meaning to make interest payments but not pay down the principal, is much easier at low rates.

When the Fed stopped buying bonds this year, rates naturally increased.

This is due to the supply and demand dynamics shifting. The Fed created artificial demand for our debt. Now that they are no longer buying, supply is exceeding demand causing the price of the debt being sold to fall, and interest rates to increase.

There were positives toward month end, such as the Fed being likely to pause any further interest rate hikes and the Treasury announcing that they would borrow $76 billion less in Q4 than originally planned. These positives set up a good start to November for stocks and bonds.

The wars between Ukraine/Russia and Israel/Hamas have added to global uncertainty.

Because of this, commodities such as crude oil are being affected. While oil prices initially increased during the month, higher interest rates and lack of signs of a spillover in either war helped decrease the price of oil as the month went on. The geopolitical uncertainty propelled the price of gold higher during the month, helping our position in bullion. Unlike oil, gold was able to hold gains throughout the month.

U.S. markets fared better than foreign markets for the month, with the MSCI Emerging Markets (EM) index down 3.89% and the MSCI EAFE (Europe, Asia, and the Far East) index down 4.05%. The EM index may receive a boost due to reports of increased stimulus measures coming from China. While we remain heavily invested in the U.S., stimulus in China would be a potential lift for several of our multinational companies in the S&P 500 index, as well as to the EM holdings in our portfolios.

Fixed Income continues to be attractive as yields move higher.

With rates above 5% on a variety of government backed fixed income securities, it is difficult for investors to ignore fixed income. In some areas of the fixed income market, such as floating rate notes, 9%-10% yields are relatively common, although tend to carry more risk than government backed securities.

Even with a negative month, the market and economy have continued to defy history.

This is largely due to increased deficit spending. While rates received some positive news at month end, there is still a historical amount of national debt that will need to be refinanced, and a deficit that keeps growing. If interest rates continue to drift upward, this will put pressure on stock prices and the economy at large. To offset some of the negative impact to stocks, the Treasury has signaled that it will issue more shorter-term securities. Like any other borrower, the Treasury does not want to pay high rates longer than necessary. While it is hard to call this a positive, it tends to be better to issue short-term securities rather than longer dated issues for the stock market.

At Central Trust Company, we continue to weigh the risks of US stocks versus the yields offered by fixed income, the valuations of foreign stocks, and the risk hedging provided by precious metals. Given the current outlook we continue to remain positioned defensively relative to our benchmarks, with less stock and more cash, fixed income, and precious metals. With a relatively cloudy outlook, now is great time to reassess the risk in your portfolio.