Investment Review for Third Quarter 2023

Risky asset returns.

In the first half of 2023—with the exception of commodities—risky assets rose. The third quarter was quite different.  During that period—with the exception of commodities—risky assets fell. 

While risky assets did fall during the quarter, domestic stocks—as represented by the S&P 500 index—remained positive for the year.  The gains, however, were not widespread.  When we break down the 13.1% S&P 500 return, we can see that it is seven companies that are generating the bulk of the return.  Seven large technology companies, nicknamed the “Magnificent Seven”, represent 11% of the gain, while the remaining 493 companies only represent 2.1% of the gain.  In fact, if we re-weight the S&P 500 so that each company is equally weighted, this representation of U.S. stocks is only up 1.8% year-to-date.   

Interest rates are rising.

One contributor to falling asset prices has been rising interest rates.  In early April, short-term interest rates were much higher than longer-term interest rates.  At that time, the 3-month treasury bill yield was approaching 5%, while the 10-year treasury note was only yielding 3.3%.  Fast forward to early October, and the 10-year treasury note is now yielding 4.75% and the 20-year rate is above 5%.  That is a significant change in just a few months.

As a reminder, rising interest rates are associated with increased borrowing costs for both consumers and businesses.  In turn, when borrowing costs are high, spending tends to fall.  Historically, this has been negative for the economy, and in turn risky asset prices.   

Labor market remains strong.

One cause for the rise in longer-term interest rates has been the resilience of the labor market. 

• The unemployment rate has fallen sharply over the past three years and has remained below 4% since early 2022.  
• The U.S. economy has averaged 260,000 new jobs per month for 2023.
• Weekly initial unemployment claims have remained below 300,000 for all of 2022 and 2023.  
• Lastly, the most recent Job Openings and Labor Turnover Survey indicated that there were 9.6 million job openings at the end of August.

While this is good news for workers, this reinforces the Federal Reserve’s view that the labor market is overheated, which could be inflationary.  As a reminder, inflation rates peaked at over 9% in 2022 and the Federal Reserve has been on a mission to bring inflation back down to its 2% target.

Higher for longer.

The Federal Reserve has been tightening monetary policy to fight inflation.  It has shown us in its actions, raising interest rates 11 times since early 2022.  Chair Powell told us with his words that the Fed intends to keep interest rates higher for longer during his August speech at Jackson Hole.  Lastly, the Fed displayed in print with their September economic projections that participants believe the appropriate interest rate for the end of this year is likely a bit higher than it is today and could remain above 5% through the end of next year. 

Washington contributes to the problem.

On September 30, the Federal government managed to pass a last-minute stop-gap funding package to avert a government shutdown, but concerns remain.  

• First, the bill only funds the government until November 17.
• Second, spending continues to far outpace receipts.  In fiscal 2023, which runs from 10/1/2022 to 9/30/2023, U.S. government debt increased $2.2 trillion.  Bringing total public debt outstanding to over $33 trillion.
• Third, the cost of financing has increased dramatically. As mentioned earlier, short-term borrowing costs for the U.S. government are now roughly 5.5%, while intermediate and long-term borrowing costs are hovering at that 5% level.
• Lastly, we are now spending down the Social Security trust fund to supplement payroll tax receipts to pay monthly obligations to retirees.  Unfortunately, the trust fund holds special-issued government bonds.  As the trust fund cashes in those bonds, the treasury department must issue new bonds at the now higher interest rate.  Over the next few years, the annual social security deficit is expected to increase from $80 billion in 2023 to over $400 billion in 2032.

Unfortunately, each of these four issues has the potential to push longer-term interest rates even higher.