As Summer gives way to Fall, equity markets typically become a more welcoming places for investors. While we don’t know what happens next, lets spend some time trying to put today’s market in context.

 

Equity Markets

 

September was again the roughest month of the year for equity markets. Positively, the next four months have often been the most rewarding for equity investors.

 

Over the last twenty years, it’s not unusual for the selloff to continue into early October before the seasonal rally gets underway.

 

Investor sentiment has improved but investors are still pessimistic enough to be a positive catalyst for equity markets.

CNN Fear & Greed Index

Source: CNN.com

 

Even with the recent pullback, there is a very small group of stocks driving market performance.  While the S&P500 is up about 12% for the year, the average stock in the S&P500 is only up about 1% year-to-date.

 

Finally, when the S&P500 is up 10-20% through the end of September, the index has a positive return in the last three months of the year 84% of the time.  The average return through the last three months of the year is +5.1%.

 

Fixed Income Markets

 

Amazingly as the term premium returns (lenders want more compensation for lending money of longer time periods) the US 20 Year Treasury continues to selloff, and investors continue to pile-in to the trade.  Since it’s peak in 2021, an ETF that tracks the US 20 Year Treasury is down more than 42% and inflows into the ETF are up more than $35bn!

 

While the selloff in longer term bonds has been painful for investors who have extended duration in their portfolios, it could reflect expectations of a healthier economic environment where central bankers modestly cut interest rates during cyclical recessions vs the ZIRP (zero interest rate policy) and QE (quantitative easing) we’ve seen in response to recent structural and event driven recessions.

Interest rates are back near a more normal level after bouncing off a 5,000-year low.

 

When the central bankers cut rates, bonds start working.

The Economy

 

We’ve seen a slowdown in most economic indicators, and employment growth is essentially back to pre-pandemic levels.

 

Unlike, July and August we could see US CPI (Inflation) tick lower as we lap larger increases in the data series from September and October of 2022.

Source: YCharts

 

With all the discussion of soft vs hard vs no landing.  We spent some time trying to understand past soft landings for the US economy.  In the last sixty-years, three times the Fed has raised rates by more than 250bps and the US economy continued to expand for three or more years. In each of these soft landings:

1. Employment and capex continued to increase even as corporate profits softened.
2. The Fed reversed course and started to loosen monetary policy within six-months of the last rate hike (currently +25bps on July 26^th, 2023), and
3. There was an impulse to sustain growth.

 

Out-of-Consensus Thought Experiments

 

While not our base case, an out-of-consensus event that could catch many investors flat footed would be if Artificial Intelligence caused a melt-up like the Tech Bubble of 1999.

NASDAQ in 1999 vs 2023

 

What’s an Investor to do?

 

Wading through a sea of conflicting data points is common in investing.  As result, we recommend investors save and invest consistently across market cycles. An investor will end up buying more securities when the market is inexpensive and fewer securities when the market is expensive. And most importantly, avoid the need to make ‘hero’ calls on market timing.

 

We continue to recommend a barbell strategy where high-quality companies exposed to secular themes provide exposure to equity markets. The other side of the barbell is: cash, actively managed fixed income, and alternative investments that reduce volatility and provide ballast for portfolios. For investors in the distribution phase of their lives, the focus expands to optimize the tax efficiency of distributions.

 

Please contact me for a more detailed discussion.

 

Delli (delli@cibc.com)

 

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