Authored by :
Michael G. Dow, CAIA, CFA, CPA, Chief Investment Officer
Julien R. Frazzo, Director of Risk Management and Securities Research
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The Quick Facts
- The U.S. market rally fizzled, with the S&P 500 down 4.8% in September and -3.3% in the third quarter
- The Russell 2000 Small Cap index underperformed, down 5.1% in 3Q
- Energy stocks maintained their spot at the top of the leaderboard, propelled by rising oil prices
- The U.S. dollar reaches fresh 2023 highs against most major currencies
- 10-year Treasury yields rose to a 16-year high as Federal Reserve (“Fed”) officials reiterate higher-for-longer rates
- Markets are currently pricing less than a 50% chance of one or more rate hikes this cycle
- Government shutdown averted, for now
As 10-year Treasury yields rose to a 15-year high, the U.S. market rally fizzled, with the S&P 500 down 4.8% in September and -3.3% in the third quarter. Pessimism amid renewed inflation concerns coupled with worries about the Fed’s hawkish guidance saw the more domestically oriented Russell 2000 Small cap index underperform, down 5.1% in 3Q. Energy maintained its spot at the top of the leaderboard and was the sole sector to post a double-digit gain (+12.2%), led by a 28.5% gain in WTI crude in 3Q.
10-year Treasury yields broke through the 2022 high of 4.2% in mid-August 2023, rising from a low of 3.3% in April 2023 to about 4.6%. Yields on 10-year German debt are close to 3%, a level not reached since 2011. Even a narrowly averted U.S. government shutdown has not spurred a sustained bid for Treasuries, the world’s haven asset. The question now is how much higher rates can go, with implications stretching far beyond markets to the rates paid on mortgages, student loans, and credit cards, and to the growth of the global economy itself.
Another headwind is a possible federal government shutdown, which was averted at least until November 17. However, the spending battle for fiscal 2024 is far from over, and a shutdown on November 18 is entirely possible.
September Asset Class Performance
At the heart of the selloff were the world’s longest-dated government securities, those most exposed to the growing list of headwinds. Everything will depend on where inflation lands over the coming months and quarters. Meanwhile, Fed officials mainly stuck to their mantra of higher-for-longer rates.
A tale of two stories can be seen at the sector level, where five of eleven sectors are in the red YTD. Growth proxy Communication Services and Technology are +37.6% and +32.6% YTD, respectively, whereas the defensive Utilities and Consumer Staples are down 14.4% and 6.0%, respectively. On a total return basis, Energy was the only sector in the green in September, with a 2.4% positive return. Energy was also the only sector to post a double-digit positive return in 3Q (+12.2%), followed by Communication Services at +1.0%, with the other nine sectors in the red. During 3Q, Utilities and Real Estate were the worst-performing sectors, down 9.2% and 8.9%, respectively.
As has been widely reported throughout the year, the robust YTD gains in the large-cap benchmarks are being driven in large part by a small group of mega-cap companies commonly known as the “Magnificent 7,” which have a 43% and 25% weighting in the Nasdaq 100 and S&P 500 indices, respectively. The Bloomberg Magnificent 7 Total Return Index (“BM7T”) was down 5.4% in September but is up +83.9% YTD. Large-cap Value stocks outperformed Large-cap Growth stocks by 1.6% in September, but the Russell 1000 Growth index is outperforming the Russell 1000 Value index by 23.2 YTD. However, over the last three years, the total return of the Large-cap Value index is ahead of Large-cap Growth by 11.0%. The ESG segment of the market, as measured by the MSCI USA ESG Select Index, was down 5.4% in September, 60 basis points more than the S&P 500. Over the last three years, the ESG index is up 28.2% and 5.4% behind the S&P 500 on a total return basis.
The U.S. 10-year yield advanced as much as 73 basis points in 3Q, and the October 2 peak at 4.69% marked a 16-year high. With the Fed at or approaching the end of its rate hike cycle, the shorter-end U.S. Treasury 2-year yield rose a relatively modest 15 basis points. This is a perfect illustration of what is called a “bear steepener.” In the trading days following the September 20 Federal Open Market Committee (“FOMC”), the spread steepened an additional 30 basis points to close the quarter at -47 basis points.
Energy prices have been soaring on the back of extended supply cuts by OPEC+ and Russia with the WTI crude rising 28.5% in 3Q to $91/bbl. Rising energy prices tax consumers and corporations at the expense of future economic activity and reduce the likelihood of a soft landing. Gold spot prices lost 4.7% in September to close at $1,849/Oz, still up 1.3% YTD. So far in 2023, gold has not been doing what gold investors were hoping for, i.e., to act as a hedge against both inflation and weakness in other financial assets. Digital asset valuations were up in September, with Bitcoin up 4.1% and 63.7% YTD, while Ethereum was up 1.9% in September and 40.1% YTD.
The U.S. Dollar Index (DXY) closed out 3Q with a streak of eleven consecutive weekly gains and reaching fresh 2023 highs. DXY is now up 2.6% YTD. The Fed’s tightening cycle that began in March of last year helped power the US dollar’s gains as higher rates attract overseas investors. A strong dollar tends to hold back stocks and other risky investments, as S&P 500 companies generate more than a third of their revenue from outside the U.S.
Interest rate volatility has been constant since the Fed began its rate-hiking cycle last year. While equity investors look to the well-known CBOE Volatility Index (“VIX”), bond investors focus on the less famous ICE BofA MOVE (“MOVE”) Index, which measures bond market volatility. The MOVE Index remains elevated at 114 compared to historical averages, which reflects the highly uncertain rate environment. The VIX closed September at 17.5 after an intra-month low at 13.0.
Chart of the Month – The Makeup of the Labor Force Post-COVID
The U.S. Labor Force Participation Rate is a measure of the percentage of the civilian non-institutional population (people of working age who are not in the military or in institutions like prisons or mental hospitals) who are either employed or actively seeking employment. It is an important indicator of the health and activity of the labor market.
The divergence in labor force participation rates between prime-age workers (typically defined as those between the ages of 25 and 54) and older workers (typically those aged 55 and older) is a notable trend in labor market dynamics in the U.S. Before the Covid-19 pandemic, there was a trend of increasing labor force participation among older workers. This was driven by several factors, including financial need, longer lifespans, and changing attitudes.
However, the Covid-19 pandemic disrupted many aspects of the labor market. It led to significant job losses across various industries, and older workers were not immune to these challenges. Some older individuals faced early retirements or job loss due to pandemic-related factors, such as health concerns and workplace closures.
As the pandemic’s effects receded and the economy stabilized, the labor force participation of older workers continues to remain below pre-COVID levels. There remains a large divergence in participation rates between prime-age and older workers.
The pandemic may have affected different age groups differently. For example, older workers might have retired earlier than planned, while younger workers may have faced challenges entering the job market. These demographic shifts can impact the labor force composition.
Quote of the Month
“There are only three ways to meet the unpaid bills of a nation. The first is taxation. The second is repudiation. The third is inflation.” – Herbert Hoover
Major Asset Class Dashboard
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