The stock market has been choppier than ever with news headlines that consume our attention day to day. A week ago, the U.S. was absorbed with what seemed like an inevitable government shut down, only to be surprised at the last minute with the passage of a bill that kept the government funded another 45 days to mid-November. A few days later, our focus shifted to the ousting of House Speaker, Kevin McCarthy. The historic event marked the first time in history that the House removed its leader, creating a void that has left the U.S. paralyzed as we witness the deadly Israel-Hamas war unfolding.
These current events have resulted in an investment roller-coaster in Q3 and lead us to wonder what lays ahead for the final quarter of 2023. The Wilshire 5000 Total Market Index, which is the broadest measure of U.S. stocks, lost about -3.3% in the third quarter of this year, but held on to a 12.5% return year to date.[i] Similarly, Large Cap stocks, as measured by the S&P 500 Index were down -3.7% at the end of September, but were still up 11.7% for the year.[ii] Small Cap stocks, as measured by Russell 2000 were down 5.1% in Q3, but clung to a 2.5% gain YTD.[iii] The tech-heavy Nasdaq lost 4.1% in the most recent quarter close, but was up 26.3% through the end of September.
International markets moved in sync with our domestic market. The MSCI EAFE Index which measures developed foreign economies posted a loss of -4.7% for the third quarter, but a gain of 4.5% for the year.[iv] Emerging Market stocks of less developed countries, as represented by the EAFE EM Index, lost -3.7% in Q3 and were down -0.4% for the year.[v]
Real Estate has been having a difficult year as interest rates have risen, making the cost of borrowing more expensive and generally slowing the market. As such, the Wilshire U.S. REIT Index posted a loss of -3.2% at September, year to date. [vi] Investor safe havens during times of market volatility such as commodities and utilities posted losses of -4%[vii] and -14%[viii], respectively, as of the end of Q3. However, since the Israel-Hamas outbreak, both of these sectors have seen an uptick in value from their lows.
Bond yields have risen steadily, hitting their highest levels since 2007 at the end of September. However, that relentless increase has subdued slightly as investors seeking a safe-haven due to the Israel-Hamas war moved into bonds for safety. This week’s shift brought the 10-year Treasury yield lower to 4.65%[ix], down from 4.74% at the end of Q3. However, the yield curve continues to be inverted, meaning short-term bonds are paying more than long-term bonds.[x] This is typically a negative market indicator which has lasted incredibly long and continues to fuel speculation of a future possible recession.[xi]
However, the recent increase in bond yields has calmed the Federal Open Market Committee (FOMC). This week, two members of the FOMC made public statements that the increase in bond yields could allow the Fed to achieve its goals to combat inflation without necessitating another increase in the Fed Funds Rate, which had been anticipated before the end of the year. This welcomed news helped the stock market recover from fear-based declines related to the Israel-Hamas war earlier in the week.
Further good news is that unemployment remains low. More people are working and their wages are trending higher. Strong signals like these have staved off doomsday pundits who often get headline attention.
Domestically, many believe the hardest economic months of the year are behind us, but the geopolitical issues create unpredictability for the end of the year. Emotionally, the Israel-Hamas war is disturbing and heartbreaking. From a stock market perspective, much of the fear induced trading that might have happened immediately after the war began was reduced by the time the stock market opened on Monday. Unfortunately, long-standing turmoil in the region may have acclimated investors to conflicts, although this is the most deadly we’ve seen in 50 years. Analyzing the market effects alone, if the war is contained to the current region, the market could progress systematically towards the end of the year. Market volatility was tempered when Iran publicly denied they helped Hamas plan the attack, deterring expansion of the war into the Middle East.
However, the war has already caused investments in oil and gas to spike as investors worry that the conflict could drive up demand for oil, or worse, spill over into the Middle East interrupting oil production and renewing inflation concerns. Additionally, investments in defense companies rose sharply, indicating the market predicts the war to have a protracted timeline, drawing comparisons to the Russian invasion of Ukraine. Money has redirected out of riskier equities into “safer” assets such as gold or bonds in the short-term. While the Israeli shekel weakened to its lowest level against the dollar since 2016, investment grade European bonds considered safe rallied. It is very common to see consumer staples and utilities gain popularity in times of turmoil.[xii]
Market analysts are noting that 2023 has followed typical patterns of seasonality. If that trend were to follow through to the end of the year, we might see strong Q4 earnings, as seasonal working and spending ensues. Further supporting this, a recent poll of economists, recorded the lowest recession expectations in a year, and opinion only here, they are not the most optimistic group of people.
Hopefully the House will pick a new Speaker soon and we will have more definitive financial and military support estimates to integrate into our short-term economic expectations. Bigger picture, volatility created by geopolitical tensions can be weathered through an effectively diversified portfolio with measured exposures to various asset classes that shift in patterns through conflicts like we are experiencing. A properly diversified portfolio can help an investor achieve their long-term goals, navigating through good and bad markets. Reach out to a Certified Financial Planner™ or CPA with a Personal Financial Specialist credential to ensure you are on the right track for whatever lays ahead.
[xi] Bob Veres Insider Information