MARKET UPDATE SEPTEMBER 2023

SUMMARY:

• The stock market is still struggling to get back to the pre-crash highs of early 2022.

• But we are still sitting well above the lows reached in October of 2022 and are still only 6% below the all-time highs in the S&P 500.

• Small cap stocks have not rebounded as much and are still well below their all-time highs.

• The major stories are still the same – interest rates, inflation, and recession concerns.

• The trend in interest rates and the fact that stocks are approaching a key resistance level (all-time highs) means that we can expect a lot more volatility in the markets in the short term.

The market rally of 2023 has stalled out since the beginning of August. As of the market close on Friday September 8th, the S&P 500 is only down about 6% from its previous peak at the start of the 2022. The Nasdaq is down about 13% from its all-time high and the Russell 2000 is still down around 24%. In the graph below, you can see the nice bounce off of the October 2022 lows. Stubbornly high interest rates, global economic concerns and the market digesting the big runup since late 2022 have us in a holding pattern right now.

The Nasdaq has climbed roughly 34% from its low in October of last year while the S&P 500 has gained about 25% since then. The Russell 2000 (small and mid-cap stocks) has only gained about 9% since October. This is more evidence of why you don’t want to own small-cap and mid-cap funds. They underperform the large cap index funds over longer time periods, and they get hit just as hard if not harder in bear markets. Advisors recommend small and mid-cap stocks for diversification, but this strategy doesn’t work and doesn’t make any sense.

This bear market has been driven by inflationary pressures and its resultant impact on interest rates. While the Fed seems to be nearing the end of its rate raising cycle, the debt markets are still struggling.

A nice way to track bonds and interest rate trends is by looking at bond prices. Remember that bond prices move in the opposite direction of interest rates. When interest rates rise, bond prices go down and vice versa. And the cleanest way to track bond prices is by looking at zero coupon bonds. Since zero coupon bonds don’t pay any interest, the total return on these bonds is reflected in the price of those bonds. We use the symbol ZROZ to track bond prices.

In this first chart, you can see the deep and steady decline of bond prices since the start of the stock market decline at the beginning of 2022. The price of these bonds is now back at the low of October 2022 which represents a loss of about 50% from the peak at the end of 2021.

As I cover in my book, FIX YOUR 401K, in more detail, this is an example of why you do not want to own bonds. You receive lower long-term returns than stocks and you get very little, if any, protection of your capital. If you purchased these bonds at the end of 2021, you were receiving an interest rate of 1.9%. We are told that bonds are safer than stocks, but how safe have they been over the last 18 months? For a measly return of 1.9%, you were exposed to a 50% loss of your principal. Again, most advisors recommend bonds in your portfolio for the purpose of asset allocation and diversification, but this approach doesn’t work on any level. Shorter term bonds have not dropped as much as longer term bonds like ZROZ, but the trends are the same.

We remain in a period of volatility and instability in most financial markets. We expect this to continue in the near term. Janet Yellen recently commented that she believes a soft landing for the economy is looking more and more likely. I don’t know her track record at predicting such things and one should never rely on these forecasts for investment decisions.

The reality is that no one knows if the worst is over or not. Because of the uncertainty, it is important to follow a disciplined approach to investing. Followers of our Market Signals newsletter are positioned to benefit if the market keeps moving higher and will be able to limit losses if the market turns down from here. It is critical to have an investing strategy that wins no matter which way the market moves. No one can predict which way things will move in the short term. But we all know that in the long term, the direction of the stock market will be higher. Stay disciplined, my friends.

Happy Investing,

Phil

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Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.