Atticus Wealth Management

THE VIEW FROM THE TOP

Market Commentary from Atticus Wealth Management
October 2023 – 4th Quarter

Navigating the Final Quarter of 2023

As we usher in the final quarter of the year, financial markets find themselves grappling with the twin challenges of ascending interest rates and a persistent cloud of economic uncertainty. These factors conspired to orchestrate a 3.3% downturn in the S&P 500 (inclusive of reinvested dividends) throughout the third quarter, while the U.S. Aggregate bond index faltered by 3.2%. On the surface, these tribulations bear a striking resemblance to the anxieties that plagued investors in the previous year when inflation and mounting interest rates ushered in a bear market. Further compounding these concerns are the recent near-miss of a government shutdown, fissures emerging in China’s economic landscape, and significant geopolitical risks in
the Middle East. In the midst of this ceaseless barrage of disheartening headlines, long-term investors find themselves seeking strategies to maintain optimism as they navigate the uncharted waters of the year’s fina stretch.

One of the enduring challenges of investing over a lifetime lies in our innate predisposition to fixate on the negative aspects. In the realm of psychology, this is commonly identified as the “negativity bias” – a cognitive phenomenon that causes us to magnify a few adverse occurrences, often overshadowing a multitude of positive developments. Investors are particularly susceptible to this cognitive bias, as positive news generally unfolds gradually, a consequence of incremental gains that accumulate over time. In stark contrast, negative news frequently materializes suddenly and without warning, precipitating drastic alterations in our news frequently materializes suddenly and without warning, precipitating drastic alterations in our expectations. Therefore, a vital discipline for long-term investors lies in retaining perspective, enabling them to appraise long-term gains against short-term risks accurately.

When considering the present state of the market, dwelling solely on the negative neglects the numerous constructive developments that have unfolded this year. In particular, despite outward parallels with the preceding year, the underpinning forces steering markets in 2023 are distinguished by several critical factors.

First and foremost, unlike the previous year when inflation surged to levels not witnessed in four decades, we now witness a substantial amelioration in inflationary pressures. The Consumer Price Index has decelerated to 3.7% on a year-over-year basis, markedly below its peak of 9.1% in June 2022. Concurrently, the core CPI has tapered down to 4.3%. Other gauges like PCE and PPI exhibit even more pronounced improvements, underscoring the stabilization of economic upheaval brought about by the pandemic’s supply disruptions and
the surge in consumer demand.

Second, the market downturn last year was rooted in the anticipation of a recession that has yet to materialize. While the possibility of a further slowdown exists, the economy has, up to this point, surpassed expectations across various indicators. The Atlanta Fed’s GDPNowcast estimate for the third quarter remains at 4.9%, and unemployment is historically low at 3.8%. The economy’s performance exceeds even the most optimistic forecasts from the previous year.

Third, after a historically rapid series of rate hikes, the Federal Reserve has hit the pause button, entering a period of observation. Consequently, it is improbable that short-term interest rates will witness a significant ascent, even if they persist at higher levels for a more extended duration. The initial tremors resulting from swift policy rate hikes are gradually adjusting within the real estate market, banking sector, and technology stocks, among others. As the financial system adapts to these rates and stabilizes, both stock and bond prices should find equilibrium.

This isn’t to suggest that investors won’t confront challenges in the forthcoming months. Instead, this panorama serves as a reminder that while markets typically ascend over protracted periods, they seldom do so in a linear trajectory. This is particularly pertinent when the market and economic environment exhibit improvement, especially when juxtaposed with the expectations investors held just a year ago. The following are five fundamental insights to guide investors in transcending the perpetual negativity in the fourth quarter and beyond.

1 Stock Momentum Versus Bond Volatility

Despite increased volatility during the third quarter, the S&P 500 maintained its positive momentum. This is a marked diference from the bearish trend observed last year, showcasing the market’s ability to bounce back unexpectedly.

On the other hand, the recent uptick in interest rates has put pressure on the bond market. Over the last two months, the U.S. Aggregate bond index has seen a marked sellof, sparking concerns of a situation akin to the previous year. Nonetheless, this year’s performance is still considerably better than the bond downturn experienced last year.

2 Interest Rates Have Risen to 16-Year Highs

Elevated bond yields can be advantageous for investors, paving the way for increased income within their portfolios. It’s essential to diferentiate the current rise in bond yields from those of the previous year. The mitigating inflation rates make bonds particularly appealing at present. This is because the “real” interest rates – essentially, the interest that investors pocket post-inflation adjustments – have seen an uptick. The 10-year TIPS yield has surpassed 2.2%, marking the most favorable environment for investor income since 2008.

Moreover, the interest rate hike observed this year is in line with the upward trend of the previous few years. Hence, the current surge in rates isn’t as unexpected or jolting for the markets as the abrupt inflation escalation in 2022. If this trajectory of higher long-term rates persists, coupled with the potential resteepening of the yield curve and sustained economic growth, it could be seen as a positive turn of events in the long run.

3 The Economy Remains Stronger than Expected

The forecasts for a 2023 recession have been confounded, as economic vitality has been the order of the year. Surpassing anticipations, consumer spending has been buoyant, while contributions from both the business sector and government have further fortified the economy. Whether this momentum can be sustained remains to be seen, but even in a less optimistic scenario, any potential recession appears to have been deferred to at least 2024.

Meanwhile, the labor landscape is a shining beacon, boasting some of the most impressive statistics ever recorded. Unemployment figures are comfortably below 4%, with wage growth approaching a hearty 4.5%. Though there has been a slight dip in job openings, the number still significantly eclipses that of the jobless populace. The manufacturing sector, as gauged by metrics like the ISM index, is still grappling with some contraction. However, its non-manufacturing counterparts continue to exhibit unwavering strength. Cumulatively, these indicators ofer a hopeful picture, suggesting that the economy has the potential to maintain its growth trajectory, especially as the disturbances from inflation and fluctuating interest rates begin to find equilibrium.

4 The Fed Expects to Keep Rates Higher for Longer

The alleviation in inflation, coupled with economic growth surpassing expectations, has tilted the scales in favor of a “soft landing” orchestrated by the Fed. The central bank, given these favorable conditions, has been able to decelerate its rate hike spree, which was previously progressing at an unprecedented speed. Such a measured approach is often welcomed by the markets, as it grants the financial ecosystem the breathing space to acclimatize to a milieu of heightened rates. Although the accompanying chart indicates that the Fed might not contemplate rate reductions until later into 2024, a regime of elevated yet consistent rates could potentially bolster both equities and bonds.

5 Investors are Fully in Control of How and When They Save and Invest

The discourse around investments frequently gravitates towards market dynamics and events. However, in reality, the behaviors and decisions of investors are equally, if not more, crucial in shaping investment outcomes. The power of early savings and investing cannot be overstated, especially given the magic of compound interest over prolonged periods. As exemplified in the provided chart, initiating an investment just five years prior can lead to significant financial disparities by the time one heads into retirement.

The market, with its myriad of movements, coupled with an incessant barrage of concerning headlines, can understandably induce apprehension among potential investors. Yet, historical trends underline a simple truth: initiating investments sooner rather than later, and maintaining a steadfast position in the market, tend to be the most reliable strategies for amplifying the likelihood of achieving financial prosperity.

6 Looking Toward 2024

The S&P 500 (SPX) closed at 4117 on Friday, dropping 107 points or 2.5% over the week. A dip beneath its 200- day moving average last week hints at a possible significant bearish shift for the broader US market. However, several trusted market indicators, like extreme market breadth and standard deviation, point to the possibility of the broader US market nearing a pivotal multi-month low within a few weeks. As a result, we’ll be closely monitoring key indicators, such as the CBOE Volatility Index (VIX), for early signs of a shift in market momentum from a downward to upward trajectory.

In the meantime, despite the many reasons to be negative, the reality is that the market and economic environment is far better than many expected just a year ago. In the final months of the year, investors should maintain perspective and continue to stick to their financial plans.