Fall 2023 Market Commentary

Steve Lear |

By Marc Usem and the Affiance Financial Investment Committee

The U.S. economy continued to grow during the third quarter with an expected increase in gross domestic product (GDP) of 4.9%. The pace of growth has been surprising this year with 2% GDP growth rates in each of the first two quarters, even as the Fed continued to raise interest rates at the fastest pace in history. The post-Covid glow of mended supply chains, continued government spending (Inflation Reduction Act and CHIPS act), an artificial intelligence (AI) technology boom, and a resilient employment market has, so far, offset the Federal Reserve’s attempt to slow the economy with higher interest rates and quantitative tightening.

The key issue facing investors continues to be the tug of war between inflation and interest rates. While inflation has declined significantly from the 9.1% high of June 2022 to the most recent 3.7% rate, it remains much higher than the Federal Reserve target of 2%. The expectation is that the Fed will continue to raise rates while inflation is above their target and the economy and employment remain strong. Whether the Fed will be able to engineer a soft landing remains an issue of active debate among economists. Most expect that the recession has simply been postponed to later in 2024 as the long lags of monetary policy take effect on an economy supported by ebbing fiscal stimulus.

The artificial intelligence (AI) euphoria which drove the largest technology companies soaring through July, cooled in the third quarter. Investors grew more concerned about the ability to maintain economic growth at above-trend rates going forward, especially as the Fed’s hawkish tone continued unabated. The S&P 500 declined by -3.2% during the quarter, with September’s -4.8% decline the worst since September of 2022. Yet the S&P 500 still remains higher by 13% for the year. Global markets fared slightly worse in the quarter with the international developed markets EAFE Index falling by -4.9% and emerging markets down -3.2%. Rising interest rates have kept pressure on bond prices with the Aggregate Bond index falling by -3.2% in the quarter and by -1% for the year.

We know that over time, diversification is one of the best ways to mitigate portfolio risk and improve long-term returns. By spreading investment dollars across a range of assets, investors can smooth out the bumps of individual investments and earn higher returns over time without taking on additional risk. However, during any discrete period of time, diversification may add to or detract from returns. This year has been a case of detraction, as the top seven companies in the S&P 500 command a record high 27% of the S&P 500 Index. The top two stocks, Apple and Microsoft, garnered nearly 15% of the index and hold the largest single and combined weights in index history. Clearly, indexing is not providing the level of diversification it has in the past.

Index returns this year are also a good illustration of the impact of concentrated stock. When examining the equal weighted version of the S&P 500, the index has returned only 1.7% this year, compared to 13% for the cap-weighted index. We recently published a White Paper on Concentrated Stock, which highlights strategies to reduce portfolio risk when investors hold more than a 15% position in a single stock or stocks. We believe today’s market conditions represent an opportune time to examine the potential impact of concentrated stock risk on your financial plan’s performance. Please contact your financial planner if you believe this opportunity may apply to you.

As we enter what is typically the strongest period for stock market performance, the fourth quarter, we remain optimistic that stocks will remain buoyant through year-end. The S&P 500 is positive in 80% of all fourth quarters dating back to the 1950s, twice as much as the next best, which is the first quarter. We know we can’t control the ups and downs of markets, but we can rely on our disciplined investment processes to provide well-designed, tax-efficient, globally diversified portfolios that suit our clients’ investment planning needs.

Thank you for your continued confidence in our work.

Sources: Federal Reserve Bank of Atlanta, YCharts, Morningstar, U.S. Bureau of Labor Statistics, Charles Schwab & Co., Forbes, St. Louis Fed, Capital Group

The views represented in this commentary are not meant to be construed as advice, testimonial or condemnation of any specific sector or holding. Investors cannot invest directly in an index. Unmanaged indexes do not reflect management fees and transaction costs that are associated with some investments. Past performance is no guarantee of future results. To discuss any matters in more detail, please contact your financial advisor.