”What is easiest to see is often overlooked”. – Milton H. Erickson
After two years, could it have been for the entirety of that time that it really was so simple? Recollecting how many thousands of words have been written debating the prospects for economic recession, inflation rising or falling and the prospects for a notable decline in the stock market due to falling corporate profits, one is struck by how many false paths have been followed. Could it be that the entire time we were gazing into our crystal balls attempting to divine the future, what we were most fearful of was what was being experienced? What if the bear market we were so afraid of experiencing these past two years, due to our need to navigate our way through an aggressive Federal Reserve rate tightening cycle, is not something we need fear as part of our future but is now part of our past?
From January 1, 2021, through May 31, 2022, the consumer price index had risen at a 9% annualized rate in those seventeen months with 10-year US Treasury rates tripling from .93% to 2.85%. From June 1, 2022, through October 31, 2023, the annualized rate of inflation has fallen to 2.6% but with Treasury rates continuing their rise to 4.88%. In the past two years through October 31, 2023, the two-year total return of the S&P 500 of -5.95% obscures the true state of negativity of the financial markets. 60% equity & 40% fixed income portfolios have declined 15.64%. The version of the S&P 500 with each stock in that index equally weighted has declined 13.9% and the S&P 600, an index of US small cap stocks, has fallen 18.6%. The price of the average investment grade taxable bond in the United States has declined 15.4%. Of the major asset classes only gold and commodities have provided investors with positive returns.
With Jay Powell preparing to take his victory lap for having placed the inflation genie back in its bottle, it might be interesting if we were to pause to consider the strength of the correlation between the falling inflation rate and the timing of the fed rate increases, which began in March 2022. Three months after that first rate increase, the inflation rate reached its peak in June 2022, although the fed had only raised interest rates by 1.5%, or less than one-third of the total of the 5% increases from March 2022 to its most recent increase on July 25th of this year. Energy prices had risen by 70% from October 2021 to June 2022. Since then, they have fallen 34%. Is that the fed’s rate increases or geopolitics? What about all of the press conferences in which Jay Powell stated that inflation was unlikely to fall to acceptable levels without a slowdown in the rate of economic growth? If this was true, then why has the rate of inflation fallen so significantly while the inflation adjusted rate of US economic growth has risen from 1.8% in the year ending October 2022 to 2.95% this past year? Perhaps the greatest mystery has been why so many of the American people have either been convinced, or perhaps convinced themselves, that the pain of higher interest rates has been in any way contributory to the return of the rate of inflation to close to its pre-pandemic levels.
Let’s be clear that the Federal Reserve is responsible for setting the Federal Funds rate, an interest rate establishing the cost of overnight borrowing, NOT the interest rate on 10-year US Treasury bonds which is set by the supply and demand for those securities in the financial markets. Nonetheless, it is quite plausible to suggest that the increase in short-term interest rates has been a significant contributor to the rise in the 10-year treasury borrowing rate. It is also a simple matter to establish that the behavior of interest rates have been the single greatest contributor to the return, or lack thereof, of the equity markets. From April 1, 2021, through December 31, 2021, the interest rate on ten-year treasuries declined from 1.72% to 1.52% and the S&P 500 rose 19.8%. From October 1, 2022, through July 15, 2023, the ten-year treasury rate remained unchanged at 1.74% and the S&P rose 27.4%. The correlation is obvious and should provide a great deal of hope to investors in the financial markets. If the Federal Reserve is responsible for the raising of interest rates and the Federal Reserve is done raising interest rates AND equity markets only need stable if not declining interest rates to move to higher levels, then perhaps it is time to prepare for the possibility of much better times for investors in the not very far distant future.
60% equity & 40% fixed income portfolios returned -2.35% in October and are now up a miserly 1.48% for the year. The S&P 500 was -2.10% for the month though up 10.7% year to date. Mid-cap and small-cap stocks were both down over 5% in the month and both now show negative returns for the year with mid-cap stocks -1.30% and small-cap -5%. Foreign developed markets were -3.5% for the month but still +3% for the year. The story of the equity market year to date remains frustratingly consistent; a stock market that continues to rise on the backs of eight single companies; Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Netflix, Nvidia and Tesla. Netflix is the worst performing of the eight returning 39.6% and NVIDIA the best returning 179%. The eight companies now represent just under 50% of the S&P 500 Growth Index which explains that indices 15.26% return year to date though down notably from its return of 26% on July 28th.
Mark H. Tekamp/November 7, 2023