Gill Capital Partners October 2023 Update
While we just sent out an update less than two weeks ago, we do, from time to time, send out more frequent communications when there is timely information to share. This is one of those times; there is a lot to discuss. In recent days, interest rates have spiked to levels not seen for 20-25 years on the back of continued economic strength and stocks have corrected in response. Further, we are about to head into another earnings season and a historically strong seasonal period for stock returns, as reflected in the chart below from Bank of America:
Interestingly, since 1930 there have been 12 years in which returns have looked much like what we’ve seen so far in 2023: January to July S&P 500 returns were up at least 10% and August to September returns were negative. In each of these 12 years, the following fourth quarters were positive, with an average return of 8.39%.
Interest Rates – Good News Is Bad News & Bad News Is Good News
Interest rates have screamed higher over the past couple of months and are now at levels not seen since 2007. Below is a chart of the yield on the 10-year U.S. Treasury, which has moved from roughly 3.6% earlier this year to just under 4.8% this week. This dramatic move higher has been in response to continued hawkish rhetoric out of the Federal Reserve and stronger-than-anticipated economic data. Yields have pushed to near 25-year highs on everything from mortgages and consumer loans to fixed income investments.
Our view – The move higher in rates has been relentless and has spooked stocks over the past few weeks. Markets are currently pricing in a very small probability of one more rate increase this year; however, many analysts now predict that the Fed is done raising rates and will begin cutting next year. What will be the impetus for the Fed to lower rates? We are not sure yet; it could be a recession, issues with banks or commercial real estate, or something else that’s not even on our radar yet. However, barring an inflationary surprise, it looks like rates are reaching their peak range. This is where good news has become bad news and bad news has become good news. The Fed is looking for signs of a weakening economy. Stronger than expected reports on GDP, jobs, and manufacturing, which are generally considered good news, may prove to prolong the tightening cycle. On the flip side, reports that show material weakness in the economy, generally considered bad news, may provide the Federal Reserve cover to stop raising rates and eventually begin cutting. The past couple of months have been painful for fixed income investors, but history tells us that relief is coming, and this could be good news for both equities and fixed income. The chart below reflects historical market performance in the year following peak interest rates in previous cycles. On average, interest rates are materially lower, fixed income prices are materially higher, and the S&P 500 is up 17.6%. It is possible that rates will continue to move higher, but based upon the current environment, we do not think that is a likely scenario.
We are not attempting to sugar coat things; the recent rapid rise in rates will likely have a tremendous impact on the economy for months, if not years, to come. We remain concerned about rates that may have risen too far too fast. The silver lining here, from an investor perspective, is that the rapid rise in rates has presented fixed income investors with one of the most compelling investment opportunities in over two decades. Investors can now lock in extremely attractive, high quality income streams for many years to come in a risk-controlled manner. We are actively doing this on behalf of clients today.
Earnings to the rescue?
October is corporate earnings month, which means investors are about to be hit with earnings reports from nearly 75% of the S&P 500. Earnings have consistently provided a strong tailwind for equities over the past few years. Will they deliver again?
Our view – With cash and fixed income yields where they are today, investors are going to need to see strong results and even stronger guidance from these companies to keep them from considering lower risk alternatives. The good news here is that guidance has been relatively flat going into the Q3 reporting season, and with the S&P down roughly 5% since the last reports, better-than expected earnings and guidance should be rewarded handsomely.
The fourth quarter is sure to be a busy one, so stay tuned for more updates, and buckle up!
As always, please let us know if you have any questions or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.