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3rd QUARTER 2023 MARKET REVIEW

Slower growth and a hawkish Fed spur volatility

10/06/2023

Close-up of a Federal Reserve façade.

Key points

Economic impact

Interest rates are unlikely to rise much further or fall quickly.

Market

Investors may want to consider rotating from cash to Treasuries and/or corporate bonds.


WRITTEN BY:
Chief Investment Strategist
WRITTEN BY:
Steve Lowe, CFA,Chief Investment Strategist

Thrivent Asset Management Contributors to this report: Steve Lowe, CFA, Chief Investment Strategist; John Groton, Jr., CFA, Director of Administration and Materials & Energy Research; Matthew Finn, CFA, Head of Equity Mutual Funds; and Jeff Branstad, CFA, Model Portfolio Manager


Key points

S&P 500 falls

The S&P 500 fell sharply in September, triggering its first negative quarter in a year

Interest rates and the economy

The stress of higher interest rates is beginning to take its toll on the economy

U.S. Treasury yields surge

U.S. Treasury yields surged to levels not seen in almost 20 years

Inflation and the Fed remain the key

The Fed was clear it intends to keep rates higher for longer


 

The U.S. economy continued to grow, and the U.S. Federal Reserve (Fed) looked increasingly likely to be near its peak in interest rates—but uncertainty and market volatility rose in the third quarter.

After a strong July, and an uneven August, the S&P 500® Index fell sharply in the second half of September. The U.S. large cap stock index was down 3.65% for the third quarter after three straight quarters of positive returns. (The S&P 500 is a market-cap-weighted index that represents the average performance of a group of 500 large capitalization stocks.)

The recent spike in 10-year Treasury yields played a major role in the stock market's September swoon. The benchmark yield blew past the 2022 high and closed the third quarter at 4.57%, a level not seen since 2007.

The core problem for both stocks and bonds were that growth looked to be softening at the same time the Fed became more hawkish—or, more precisely, the market was finally accepting the message that the Fed will remain hawkish until inflation approaches its target level, closer to a 2% long-term average rate.

The impact of tighter financial conditions, thanks to the Fed’s previous rate hikes, became more apparent over the quarter. Real rates—the interest rate paid above the current inflation rate—spiked as Treasury yields surged while inflation expectations remained relatively stable. This puts stress on rate-sensitive industries, such as banking and commercial real estate, as well as the consumer.

Unsurprisingly, the much-lauded strength of the consumer continued to ebb over the quarter, particularly in lower-income segments where loan delinquencies rose and short-term pay-day loans rose 35% in the past year, according to data from LexisNexis. More broadly, total credit card debt surged to above a record $1 trillion, according to the Fed, while the latest Fed study of household finances indicated that most U.S. households have depleted their excess savings (built up in part by pandemic stimulus payments) to the point where they now have less than they did before COVID. While the surge in employment late in the quarter is good news for the consumer, it remains to be seen whether September’s surge is an outlier or results in an even more hawkish Fed.

Meanwhile, inflation remains high. While it has drifted lower recently, the 3.3% year-on-year rise in the July Core Personal Consumption Index (PCE) measure, a common gauge of inflation, is still well above the Fed’s target rate. And we believe the last percent or so will be the hardest to wring out.

Indeed, stubborn inflation is why we think the Fed has been increasingly clear about its higher-for-longer message. At the Fed’s September meeting, they announced a target policy rate of 5.0% at the end of 2024 and 3.9% two years out. This was a significant rise from the Fed’s expectations just six months ago that the same rates would end 2024 at 4.3% and 2025 at 3.1%.

It was a difficult quarter for financial markets. That said, we continue to believe that uncertainty, and thus volatility, is particularly high around turning points in the economic cycle. While the short-term effects of volatility can be painful, these same periods can also offer opportunities for actively managed investment portfolios. 

For more on the economy and our outlook for the markets, see: Thrivent 4th Quarter Market Outlook, by Chief Investment Strategist Steve Lowe 

Drilling down

U.S. stocks slide

After a strong first half to the year, the S&P 500 Index dropped 3.56% in the third quarter as the combination of slowing growth and higher Treasury rates weighed on investor optimism for a soft landing. Over the period, the index fell from 4,450.38 at the end of June, to 4,288.05 at the end of September. The total return of the S&P 500 (including dividends) was -3.27% lowering its year-to-date total return to 13.07%.

 

The Nasdaq Composite Index was down 4.12% in the third quarter, from 13,787.92 at the end of June, to 13,219.32 at the end of September, lowering its year-to-date gains to 26.30%. (The Nasdaq – National Association of Securities Dealers Automated Quotations – is an electronic stock exchange with more than 3,300 company listings.)

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Retail sales continue to rise

Retail sales in August were up 0.6% from the previous month, according to the Department of Commerce report issued September 14. For the three-month period from June through August, sales were 2.2% higher than the same period a year earlier.

The year-on-year rise was led by food services & drinking places (up 8.5%), health and personal care stores (up 7.8%), and non-store retailers (primarily online) which was up 7.2% from a year ago.

The month-on-month rise from July to August was led by a sharp rise in gas station sales (up 5.2%), though this figure is skewed by the surge in gas prices, which rose 7.36% from the end of July to the end of August. 

Payrolls surged in September

After a lackluster July and August, nonfarm payrolls increased by 336,000 in September, according to the October 6 report from the Department of Labor. The figure was almost double the consensus estimate of nearly 170,000 jobs, and the largest monthly increase in payrolls since January. Additionally, the payrolls of July and August were revised higher by 79,000 and 40,000 jobs, respectively.

The unemployment rate (3.8%) was unchanged in the September report, and part-time employment was relatively unchanged as well, rising only slightly. Average hourly earnings rose 0.2% in September, lower than expected, to $33.88, a rise of 4.2% from September 2022. 

Most sectors fell in the third quarter

Of the S&P 500’s 11 sectors, all but Energy and Communication Services had a negative return in the third quarter. The Utilities (down 9.25%) and Real Estate (down 8.90%) sectors suffered the most, but a reversal in previously strong sectors like Information Technology (IT), down 5.64%, and the Consumer Discretionary sector, which fell 4.80%, signaled the breadth of the market’s correction over the quarter. Energy was the strongest performer, fueled by surging oil prices. 

Year to date, the dispersion of sector performance remains broad. Communication Services leads the market with a 40.43% gain, followed by IT, at 34.72%, while Utilities remains the worst performing sector, down 14.41% year to date. The Energy sector was the second-worst performing sector after the second quarter, but its strong gains this quarter pushed it into positive territory, at 6.03% year to date.

The chart below shows the results of the 11 sectors for the past month, third quarter, and year to date. 

Treasury yields surge

The yield on 10-year U.S. Treasuries soared in the third quarter, rising from 3.81% at the end of June to close the quarter at 4.57%—a level not seen since 2007. Hawkish statements from the Fed and the potential impact of surging oil prices on inflation, prompted investors to expect interest rates would remain higher for longer than previously anticipated.

As interest rates rose, the Bloomberg U.S. Aggregate Bond Index, which tracks the performance of U.S. investment-grade bonds, fell 3.23% in the third quarter, and is down 1.21% year to date. 

 

Corporate earnings projections keep rising

Corporate 12-month earnings projections for the S&P 500 continued to rise from expectations that were lowered in 2022 and the first part of 2023. EPS estimates rose more than 3% in the third quarter. While rising earnings projections may seem at odds with expectations for a slowing economy, the largest technology and technology-related companies—the so-called “mega cap” stocks, like Apple, Alphabet and Amazon—continue to be seen favorably.

 

Forward P/E ratio softens

The forward 12-month price-earnings ratio (P/E) of the S&P 500 slipped over the third quarter, from 19.14 at the end of June to 17.83 at the end of September. A lower P/E means stocks are less expensive relative to their earnings per share.

 

The forward 12-month earnings yield for the S&P 500, which is the inverse of P/E, rose 7.29% over the period. The 12-month forward earnings yield can be helpful in comparing equity earnings yields with current bond yields. The September-end 5.62% equity earnings yield is still well above the 4.57% yield 10-year U.S. Treasuries offered at the end of September, but the gap continues to narrow.

 

Dollar gains vs. euro and yen

The U.S. dollar appreciated 2.96% versus the euro and 3.24% versus the Japanese yen during the third quarter of 2023, as expectations for the Fed to keep interest rates higher for longer, and the resulting rise in Treasury yields, may attract greater investment into securities denominated in dollars.

 

Oil prices surge

Oil prices rose swiftly and steadily over the third quarter, with the price of West Texas Intermediate, a grade of crude oil used as a benchmark in oil pricing, rising 28.52%, from $70.64 at the close of June to $90.79 at the end of September. The primary cause was the announcement of further production cuts—and the extension of those cuts into year-end—by the members of OPEC+ (a consortium of oil producing nations), notably Saudi Arabia and Russia.

Gasoline prices at the pump rose 7.54% in the third quarter from $3.68 at the June close to $3.96 at the end of September.

 

Gold prices fall

Gold prices fell again in the third quarter, down 3.28%, from $1,929.40 at the end of June to $1,866.10 at the end of September. The decline can be largely attributed to expectations that tighter monetary policy, slowing economic growth, and higher U.S. Treasury yields could result in lower inflation.

 

International equities fall

After three quarters of strong growth, international equities also corrected lower in the third quarter of 2023, falling 4.71% and lowering its year-to-date return to 4.49%, as prospects for global economic growth continued to deteriorate. The MSCI EAFE Index, which tracks developed-economy stocks in Europe, Australasia and the Far East, fell from 2,131.72 at the end of June to 2,031.26 at the end of September.

 

What can you expect from the economy and the markets in the months ahead? See: Thrivent 4th Quarter Market Outlookby Chief Investment Strategist Steve Lowe 

Media contact: Callie Briese, 612-844-7340; callie.briese@thrivent.com

All information and representations herein are as of 10/06/2023, unless otherwise noted.

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Thrivent Asset Management, LLC associates. Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

Any indexes shown are unmanaged and do not reflect the typical costs of investing. Investors cannot invest directly in an index.

Past performance is not necessarily indicative of future results.

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