Folks might remember (the artist formerly known as) Prince saying “I’m gonna party like it’s 1999”, well, the markets took their cue from this during the last quarter in the market partied like it was 2022 – almost literally (the Russell 3000 broad market was down 5.9 percent in Q3 2022). A year ago, the equity market – and risk generally – fell to its knees before the Fed as it figured out that rates were going even higher. History does not repeat itself, but it does often rhyme. Risk markets once again fell to the fed as it (the Fed) raised rates yet again in July and guided “higher for longer”. A reset often requires a rethink and, therefore, a revaluation – and that is just what we got.
- The Federal Reserve Bank raised the federal funds rate by 50 basis points (0.50 percent) during the quarter, 25 basis points in July and another 25 basis points in September. After the September meeting, the Fed reiterated their “higher for longer” mantra and did not dismiss another rate hike (see our update here).
- Economic growth (as measured by Gross Domestic Product, of GDP) clocked in at 2.1 percent (annualized quarter-over-quarter), 0.10 percent higher than the second quarter.
- Inflation, as measured by the consumer price index (“CPI”), was last reported at 3.7 percent (year-over-year, or “YoY”) after beginning the quarter at 5.0 percent. Excluding the more volatile food and energy components, or core CPI, inflation was last reported at 4.3 percent YoY after beginning the quarter at 5.6 percent. Inflation, by nearly every measure, has been softening as the year progresses.
- Non-farm payrolls, or employment, were softer and subsequently revised lower for July and August.
- Consumer sentiment (the consumer drives the economy) started the quarter off stronger, but subsequently fell as higher rates and continued inflationary pressure took hold.
- Global equities (as measured by the MSCI All Country World Index “ACWI”) were 3.3 percent lower during the quarter, as central banks continued to tighten monetary policy, and global growth softened.
- Domestic equities (as measured by the MSCI USA Index) declined by over 3.2 percent due to factors such as the “higher for longer” federal funds outlook, the possibility of a recession, and weakness in growth focused equities. While growth was a focus, weakness was broad-based.
- Growth underperformed value, and decidedly so in small cap stocks.
- In the US, Energy was the only subsector with a positive return (12 percent), while utilities and real estate dramatically underperformed (with returns of approximately -9 percent).
- Interest rates increased across the yield curve, the increase was most pronounced in the longer-term tenors of the curve.
- The yield curve steepened during the quarter with the 2y – 10y Treasury curve increasing from -106 basis points to -47 basis points. As shown in the rates tables/charts below, the steepening was due to increases in longer-term rates. This increase was driven by a number of factors including supply and an increasing term-premia (the compensation needed for the uncertainty of time).
- Municipal bonds widened with treasuries and are currently at decade high yields.
Consumer Sentiment: After showing some strength, the index has recently moderately weakened.
Source: Bloomberg, BCIS
Nonfarm payrolls: Payroll additions have been softening, but not enough for the Fed.
Source: Bloomberg/BCIS. Note: chart is truncated (during 2020 period) for usability.
Consumer Price Index: Inflation has been steadily heading down, but recent increases in oil threaten progress.
Overview: A difficult month and quarter due to the probability of “higher for longer”
Sectors: there was broad-based weakness across sectors, except for energy.
Rates: Rates increased across the curve, with the biggest increase in longer tenor rates.
Yield curve: The yield curve bear steepened as long-tenor rates increased more than short-tenor. A steeper curve implies greater uncertainty.
Spreads: Given the higher absolute rates, demand for fixed income increased, tightening spreads. Spreads are the “risk premium” part of a bond’s yield.
Municipals: Muni yield rose with treasury yields.
All Data as of September 30, 2023
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Name of the author: Mike Terry, CFA