As we enter the 4th quarter of 2023, investors find themselves with more questions than answers and increasingly surrounded by drama (even more so than usual). Let’s examine the oddities by exploring a few charts and graphs.

The Consumer Drama

The consumer is likely starting to feel the pinch of (1) higher interest rates and (2) the continued impact of inflation over the last 24 months.

“Personal interest payments” have jumped considerably over the last year and now amount to more than $500 billion across the country. These “interest payments” reflect only the “interest” portion of payments for things like car loans, credit cards, and personal loans, but it doesn’t include interest on mortgage payments. Over the last 18 months or so, cumulative interest payments have increased by approximately $200 billion dollars.

Speaking of mortgages, the 30-year mortgage rate is approaching 8% and median housing payments in the US is now around 43% of the median income. This exceeds the 2006-2007 ratio that proceeded the mortgage / housing issues in the US in 2008-2009. Ultimately, this ratio is a function of increased mortgages rates and a lack of supply in the housing market (leading to high prices). As mentioned last month, housing affordability is among the poorest on record, with no sign of relief at the moment.

Another consideration for consumer spending is the resumption of payments for student loan borrowers. As you may recall, in March 2020 student loan payments were placed on hiatus. Three years later, the requirement for payments has resumed. On the surface, this may not sound large a strong headwind, but the chart below suggests that the volume of student debt is still rather staggering across all ages. Granted, this debt isn’t a new issue, but borrowers likely grew accustomed to the temporary halt in payment requirements and may need to made adjustments in order to continue making payments. Thus, another headwind for consumer spending.

Higher interest payments, expensive housing options, the repayment of student loans, and the recent bout of inflation all spells the same conclusion for consumers = less discretionary income.

So, what does all of this mean for stocks?

Concentrated Performance in Stocks

Thus far, in 2023 the performance of the S&P 500 has been a bit of a mirage. On the surface, the S&P 500 has had a pretty good year; posting gains of about 11% through September, but that’s a little misleading when we dig deeper. Seven stocks (affectionately referred to as the “magnificent seven”) have accounted for all the gains in the market this year. Apple, Amazon, Meta, Alphabet, Nvidia, Tesla and Microsoft are up an average of 81% in 2023 while the remaining 493 stocks have averaged a slight loss on the year. Because those seven stocks have a large weighting in the index, they’ve effectively buoyed the returns for the entire market. For investors without a significant allocation to these large-cap names it’s been tough sledding.

Should investors scrap the idea of diversification and focus on these seven bellwethers exclusively? Probably not at the current valuations. These seven giants trade at a valuation that’s more than twice as expensive as the broad market in terms of price / earnings ratio (per Morningstar P/E data). I wouldn’t be surprised if the next 12 months gives us some reversion to the mean in terms of performance.

Drama in Bonds

Stocks haven’t been the main story for 2023 (at least not yet). The real story has been the drama playing out in the bond market. As a refresher, interest rates and bond prices move inversely of one another. Prices of existing bonds decline as interest rates rise. For example, imagine that you bought a bond paying 3% in 2021 and wanted to sell it today. 3% was a decent rate in 2021, but it isn’t today. With interest rates north of 5% for most fixed income investments, your bond couldn’t be sold for the original price that you paid. Investors would simply buy a new issue bond at a higher rate. If you sold your 3% bond early then you would take a loss compared to the original price of the bond. With rates rising over the past few years, bond values have declined considerably (that’s an understatement).

In fact, if the calendar year 2023 were to end today it would mark the third consecutive year for declining bond values (as measured by the return of the 10-year Treasury bond). This has never happened in the modern-day history of bond returns going back to 1928. The magnitude of the losses is equally as staggering with a cumulative loss of nearly 25% over the three-year time frame.

Still, these returns look relatively attractive compared to the cumulative decline of nearly 60% in longer-dated Treasury bonds. Believe it or not, the decline in long-dated Treasury bonds (as measured by the iShares 20+ Year Treasury Bond ETF (TLT)) is now larger than the stock market decline during the Great Recession of 2008-2009.

Despite the decline (or perhaps because of it) investors are piling into long-dated bonds with the belief that rates will ultimately decline and bond prices will appreciate. The white line in the chart below signifies total assets invested into the previously mentioned Treasury bond ETF (symbol TLT).

Bond investors have had a difficult time regardless of their chosen investment vehicle. Perfect foresight into the inflation issues over the last two year would have suggested that “Inflation Protection” Treasury bonds may have been an attractive way to hedge the risk of inflation. Although it certainly sounds correct on the surface, that assumption would have yielding very disappointing results. Since the start of 2021 inflation has increased approximately 17% as measured by CPI while the Inflation Protection Bonds (as measured by the iShares TIPS Bond ETF) declined by 8% cumulatively. So much for hedging against inflation.

The Drama in Washington

Finally, it’s worth noting that the drama in Washington is near fever-pitch as well. While politics rarely have a lasting impact on financial markets (seriously, you’d be surprised at how little it matters). The ousting of Speaker McCarthy does increase odds of a deeper and longer government shutdown in November as it increases uncertainty that a spending agreement can be reached in a timely manner. Generally speaking, markets don’t like uncertainty.

So where does this leave us in terms of the investment landscape? Well… as we highlighted last month, it’s getting increasingly difficult to argue with 5%+ yields on money markets and CDs. We continue to believe that a recession can’t be avoided in the next 12 months. The questions in our mind are (1) what part of the economy will “break” first and (2) will the Federal Reserve come to the rescue as they did in the previous recession. Regardless, recessions have historically created attractive opportunities and provided investors with solid returns on the other side.

For clients in discretionarily managed accounts, we will continue to abide by our self-imposed investment discipline. Once the 5-day average price of stocks (as measured by the S&P 500) falls below the 200-day average price of stocks, we will reduce our stock holdings by half. At the time of this writing, the stock market continues to show resilience in the face of the drama and pending headwinds and remains above the “trigger point” of our sell-discipline.

Any opinions are those of Brady Raanes and not necessarily those of Raymond James. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Expressions of opinion are as of this date and are subject to change without notice. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Investments mentioned may not be suitable for all investors. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Prior to making an investment decision, please consult with your financial advisor about your individual situation. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance.