*Originally published September 15, 2023
By Tim Courtney, Chief Investment Officer
2023 has demonstrated the swift ebb and flow of market sentiment. What was initially a year earmarked with recession concerns has been a rollercoaster of optimism and pessimism, often changing within weeks. This dynamism poses both challenges and opportunities for investors, especially when deciphering the signals from different segments of the market.
While the equity market has largely been giving two thumbs up, the bond market has flashed cautionary signals. With longer-term rates falling in the early part of the year, the yield curve has remained inverted and as such, has signaled trouble ahead. However, the tide may be shifting. For instance, after touching a low of 3.3% in April, the 10-year Treasury yield has rebounded and recently topped 4.3%.1
What does this mean? The upward trajectory in longer bond yields could suggest better alignment between the bond and stock markets. The bond market may be saying that growth this year and into next may be strong enough to avoid a recession.
Looking at stock prices, that is what the stock market has been saying for several months now. There seems to be a growing consensus around the likelihood of a soft economic landing despite the high interest rates. As homeowners with mortgages locked in at 2.5% are hesitant to sell, housing supply remains constricted, keeping prices fairly high. Coupled with the fact that markets are near highs means consumers have remained confident enough to keep spending.
Of course spending has remained high at the household level and at the government level. We are starting to see credit card and car loan defaults rise. Fitch's downgrade of the U.S. credit rating and the rising level of our national and state debt should cause investors who want rates to fall to pause.
We believe that we are likely nearing the culmination of the Federal Reserve's interest rate hikes. More increases may be coming, but we are most of the way through the hikes so that the Fed can now evaluate whether excessive money supply, inflation, and speculation have been tamed.
This evolving market landscape has key implications for investors owning cash and bonds. The era of meager returns for bondholders has been waning and higher rates are rewarding fixed income investors for the risks (like inflation) they have been taking. Diversification in your fixed income allocation remains essential. While short-term rates are currently higher than long-term rates, that won’t always be the case. We can’t know when things will shift, so it’s important to own bonds across different parts of the yield curve.
2023 has been a testament to the unpredictability of markets. In such volatile times, diversification remains an investor's steadfast ally. If you have any questions, please contact your Exencial advisor.
Sources:
1. YCharts (8/21/23) - 10 Year Treasury Rate (I:10YTR)
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