By Edward Miller, CFA®, CMT®
After both stocks and bonds posted robust returns in the first half of the year, with the 3Q came an abrupt halt to any further gains. The S&P 500 rose nearly 17% through the 2Q but declined by 3.3% in the 3Q. The Barclays US Aggregate Bond Index enjoyed a 2.3% gain through the 2Q but suffered a 3.2% loss in the 3Q. Most other major asset classes experienced negative returns in the 3Q, with commodities being the notable standout winner, posting a gain of nearly 5%.
Why the near-universal hemorrhaging of returns in the 3Q? The price of crude oil took off in the quarter, soaring by 29%, as overall inflation remained stubbornly elevated despite peaking and trending lower since late last year. In response, interest rates headed higher with the 10-year Treasury yield climbing from 3.9% at the end of the 2Q to nearly 5% in late September. When interest rates rise, bonds fall, but equity investors also became concerned that the Fed would maintain its hawkish stance on inflation, keeping interest rates relatively high and further draining liquidity from markets.
As discussed in my 2Q letter, the YTD positive performance of the S&P 500 can be attributed to just seven stocks: Apple, Microsoft, NVIDIA, Meta (Facebook), Amazon, Tesla and Alphabet (Google). In fact, through the 3Q, the average gain for these seven stocks was +88% compared to an average gain of just +2% for the remaining 493 stocks in the Index. The following chart further illustrates this staggering disparity in returns:
The S&P 500 Index is up 13% for the year through the 3Q, but the equal-weighted S&P 500 has risen by a meager 1.7% in that time. It’s fair to say that not owning these seven stocks has made it exceedingly difficult to outperform the S&P 500 this year.
With respect to the seemingly long overdue economic recession, when will it finally arrive, if at all? It’s starting to become like the boy who cried wolf! As I’ve shown in prior quarterly investment letters, several proven indicators have been signaling a recession is forthcoming and imminent, and those indicators remain steadfastly bearish on the economy. For example, the following chart shows the 6-month growth rate of the Leading Economic Index (LEI):
When the LEI descends below 0%, and especially when below the red line, a recession has typically occurred (see grey shadings in chart). The LEI has been below the red line since last year and yet the US economy has remained very resilient, avoiding a recession despite the many negative indicators.
At this point, can we assume it’s different this time, that the indicators are wrong and we’ll avoid a recession? In my experience, the phrase “it’s different this time” is always proven wrong as it rarely if ever is different this time. Also, indicators calling for a recession have historically exhibited a lag effect, with eventual economic weakness materializing anywhere between one to 18 months later. The exact timing can vary depending on the confluence of factors and circumstances prevalent during each period.
It's my contention that a primary reason for the long delay of this expected recession is due to the massive stimulus injected into the economy in response to the COVID-19 crisis of 2020. Approximately $5 trillion of federal aid went to individuals, businesses, and state & local governments. It was by far the largest federal aid outlay in US history. This enormous stimulus worked to shorten the pandemic recession then to just three months, the briefest on record. Although this government aid is now about three years old, given its size, it continues to bolster our economy as the ripple effects of such huge stimulus can sustain long after the initial outlay of money.
The following chart helps to put in perspective the magnitude of the COVID stimulus to individuals:
As shown above, post-COVID, individuals received nearly $1 trillion in direct payments from the government, as compared to much smaller figures during the Great Recession of 2008 and the recession of 2001.
Again, as a reminder, the federal government stopped issuing COVID-related aid in early 2021. In addition, since the start of 2022, interest rates have rocketed higher with the 10-year Treasury yield rising from 1.75% to nearly 5% in that time. In such a liquidity-draining environment, the existing stimulus – which arguably postponed the economic weakness we would’ve normally experienced – will eventually dry up and its beneficial impact will greatly diminish.
Of course, no one ever wants a recession, but when it comes to investing, it’s always best to remain clear-eyed and objective when assessing the macro environment and analyzing the data. As written in past quarterly letters, “Our client portfolios have been positioned defensively since late 2021 and have remained so to date.” Until we see more convincing indications that a recession is unlikely, we continue to err on the side of caution.
To close on a more uplifting note, seasonally the stock market is entering its most bullish period in the calendar year. As the following chart depicts, the S&P 500 rally this year (red line) did indeed confront some headwinds in the 3Q as was expected given the historical seasonal trend (grey & black lines). But once October comes along, equities tend to rise through December, often at an impressive rate.
As always, if you have any questions, please feel free to call or email. The entire team at Measured Wealth wishes to thank you for entrusting us to deliver on your financial goals.
Ed Miller, CFA, CMT
Chief Investment Officer
Measured Wealth Private Client Group
Important Disclosures
Historical data is not a guarantee that any of the events described will occur or that any strategy will be successful. Past performance is not indicative of future results.
Returns citied above are from various sources including Factset, Bloomberg, Russell Associates, S&P Dow Jones, MSCI Inc., The St. Louis Federal Reserve and Y-Charts, Inc. The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. Investing involves risks, including possible loss of principal. Please consider the investment objectives, risks, charges, and expenses of any security carefully before investing.
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