Spring is certainly in the air for investors. The index finished up for the month, and while the pace of this growth is likely unsustainable, there are reasons to be optimistic that the returns can continue to stay positive for the remainder of the year.
Fall is in the air, and the US stock market has taken its cue, with the S&P 500 index posting the worst month this year, falling 4.77%. This makes back-to-back months with falling equity prices. Bonds were not much better, falling 2.54% for the month. The decline in both markets was primarily due to interest rates increasing throughout the month. Federal Reserve (Fed) Chairman Jerome Powell and the Federal Open Market Committee decided to leave interest rates unchanged during the September meeting, which would have sparked a rally just a few months ago. However, his and other Fed Governors’ commentary after the meeting convinced the market that the Fed is going to keep rates high for the foreseeable future.
The market has been anticipating and hoping for rate cuts for over a year now, and investors continue to look for any signs that rates will stabilize, and then potentially be cut. It was just back in March and April that investors were pricing in significant rate cuts starting in July. The economy has held up far better than economists and investors expected. With continued inflationary pressure from wage increases and higher oil prices, the overall view in markets has shifted dramatically in the past two months. Inflation will be difficult to reduce to the Fed’s 2% goal from where we are currently.
Increasing rates will continue to put pressure on the economy, but they have provided a benefit to savers. Total returns for bonds don’t look great currently, but the income being generated is substantially higher than in the past few years. If rates are cut in the future, these total returns will likely turn positive from the bond principal appreciating. A key factor contributing to the increase in longer-term interest rates is the amount of debt being issued by the government.
Per a Department of Treasury Press release from July 31, 2023, the Treasury expected to borrow $1.007 trillion from July to September, and an additional $852 billion from October to December. Since 2019, the Fed has been a major buyer of Treasury debt. In fact, the Fed’s balance sheet stood at just over $3.76 trillion in assets in August 2019. By April 2022, the balance sheet ballooned to $8.96 trillion in assets. The increase was from the Fed buying $5.2 trillion in government debt. Since bond prices move opposite interest rates, having a buyer like the Fed kept the interest rates low. Now, the Fed is no longer buying debt from the government. As of September 27, 2023, the assets on the Fed Balance sheet were $8.06 trillion. Without having a major buyer like the Fed, and the US Treasury issuing record levels of debt securities, interest rates have increased to incentivize investors into absorbing the supply coming out of Washington. It is important to remember that the Fed sets the short-term interest rate, referred to as the federal funds rate or the overnight rate. The market determines the interest rate on all other debt maturities, although the Fed has developed various tools to influence longer-term interest rates.
Further weighing on stock returns is the increase in the value of the dollar relative to global currencies. After bouncing off lows for the year in July, the dollar has moved higher in the past two months. A stronger dollar makes it difficult for US companies with foreign operations to compete and decreases earnings. Typically, a stronger dollar results in commodity prices being lower. However, oil remains stubbornly high, with demand outpacing supply keeping the price elevated. Over much of the last decade, US shale drillers increased production as oil prices climbed. Even though the US is on pace to produce the most oil in our history this year at an average of 12.7 million barrels per day, oil producers are not increasing production fast enough to reduce prices. In fact, oil companies have given every indication that they do not plan to increase production. Data from Baker Hughes shows that there were 142 fewer drilling rigs operating in September compared to the same time last year.
On the positive side unemployment remains low, and workers continue to have bargaining power, resulting in higher wages. Higher wages translate into more spending ability, which accounts for roughly 70% of the US economy. Even with mortgage rates climbing to multi-decade highs, it is estimated that 80% of borrowers hold mortgages that are below 5%. The lower rates on existing mortgages have helped keep residential real estate prices stable since people are reluctant to move into a home with a higher rate of interest on the mortgage. Similar to oil, demand continues to exceed supply in most markets. Of course, all of these positives also come with the side effect of being inflationary.
At Central Trust, 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 positive year-to-date returns still in most asset classes this year, it is a great time to review the risk in your portfolio and see if changes should be made.
If you are wondering how your assets translate into securing your future, a financial plan is a great place to start. Please reach out to your team here at Central Trust Company to create or update a financial plan. To access our full monthly outlook, please click here. As always, we are always ready to help!
Investment commentary by Jason Flores, CFA, CAIA – Executive Vice President & Chief Investment Officer at Central Trust Company.
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