Thursday, October 19, 2023
As we have seen in the past quarter, the yield on the 10-year US Treasury went from 3.818% at the end of June 2023 to today’s 4.94% rate. As interest rates go up, bond prices come down and the higher the duration – or the sensitivity of a bond portfolio’s price to changes in interest rates – the bigger the impact. The gains that our intermediate bond funds (3-7 years in average duration) experienced at the beginning of the year have largely dissipated and left us with breakeven intermediate bond returns – for those of you who hold bonds. Don’t be discouraged, however. Many analysts believe intermediate bonds could rally in the coming quarters. The shortterm side of things are having a better year. PIMCO Short-term Institutional is up 4.60% (6.13% annualized) and Vanguard Short-Term Investment Grade bond is up 2.13% (2.84% annualized).
The increase in yields last quarter also had a negative impact on the equities we all hold in our portfolios – the S&P 500 was down 3.27% in the third quarter. Companies with a lot of debt on their balance sheet will be paying more in increased interest rates to service that debt in the future. This is one of the reasons why small companies have taken it on the chin so far this year – they tend to have more debt on the books than their larger cap brethren. As you know from our last quarter-end letter, the magnificent seven stocks like Nvidia, Microsoft, Apple and Amazon among others, are the main reasons the S&P 500 is up 13.07% so far this year. Artificial intelligence (AI) is the chief driver for their solid returns as investors bet on the potential of this new income stream. Ed Yardeni, a research analyst I follow, believes that the magnificent seven might be relatively safe going into a slowing economy as they don’t hold as much debt as other smaller companies do; thus, they won’t be as impacted with higher interest rates. That would be good for our total stock market and S&P 500 index funds as all of the magnificent seven stocks are part of the top 10 names in each of those indexes.
One of the phrases that kind of spooked the stock market over this past quarter was the headline that the Federal Reserve plans on keeping rates “higher for longer” to bring inflation down to their 2% target. PIMCO, one of our fixed income managers, believes the Fed will have one more quarter-point rate increase by the end of the year which means we are very close to peak rates. With peak rates, PIMCO believes intermediate bonds are a great value right now – even better than equities. Peak rates also mean that home sales and refinancings will slow as rates stay high for longer and that will certainly have an impact on the overall economy. Moreover, corporations will not only have higher debt service expenses, but I think they will also have headwinds from a consumer that will be spending less in the coming months. We also have heightened geopolitical risks with the terrible atrocities that took place in Israel along with the on-going war in Ukraine and the risk with either or both conflicts spreading to other countries (my thoughts and prayers are with all of the families impacted by these events!). I believe when you add it all up, we will most likely have an economic slowdown. After all, isn’t that what the total stock market predicted when it was down 19.5% last year? Should we end up in an economic recession, I believe it will be a shallow one. Also, don’t dismiss an equity Santa Claus rally to close the year.
Enclosed you will find your Portfolio Holdings statement as of September 30, Performance Analysis and Position Performance summaries and a quarterly Account Management Fee Statement. Please contact us for the latest version of the Form ADV Part 2A. Should your investment objectives or personal financial situation change, be sure to call us.
P.S. Keep in mind that the Schwab Value Advantage Money Market’s 7-day effective yield is 5.25%; thus, another 0.25% increase by the Fed would bump the yield even higher. This might be a good option for any emergency funds. Give us a call with any questions.