Trick or Treat?

The National Retail Federation projects Americans will spend over $12 billion dollars on Halloween this year, surpassing last year’s record of $10.6 billion.  Last fall, most economists and money managers were on the lookout for a recession in early 2023.  Instead, the economy has continued to grow.  In fact, growth has been incredibly strong with the US economy growing by a stunning 4.9% last quarter defying predictions of a slowdown.  Consumer spending has remained robust, but people are dipping into their savings to prop up their spending which can only last for as long as there are savings from which to pull.  In addition, while Inflation has been falling it remains higher than the increase in wage income. So where does this leave the markets?  Will the rest of the year be filled with Tricks or Treats?

Tech stock returns, especially from the Magnificent Seven, had been strong this year, but according to CNBC, the Nasdaq Index entered correction territory on October 26^th and is now down over 10% from its July highs.  Not to be left out, according to Bloomberg, the S&P 500 is down over 9.8% from its peak.  The primary cause of falling prices appears to be the concern that a strong economy will keep interest rates elevated for longer than was originally expected.  Higher rates are especially tough on companies that need to fund their growth through the debt markets – funding growth by issuing debt at 8-10% is a tougher challenge than 2-4%.  This hurts margins, which hurt profits which ultimately hurt stock prices.  The longer rates stay higher, the worse the pain for these types of companies.

At some point the market will most likely rotate away from the high-flying tech companies into other sectors that provide solid growth potential and pay a good dividend.  Value stocks have underperformed growth stocks for quite some time and that may finally be changing, which could benefit those who own well diversified portfolios.  According to JP Morgan’s Global Equity Views 4^th quarter 2023, valuation spreads between value and growth stocks are in the 85^th percentile, which is extreme and could be a signal that value stocks could be well positioned going forward.

Another area of the markets that looks to be selling at a discount are international stocks, which according to JP Morgan, are 30% cheaper than US stocks as measured by the S&P 500 index.  This is the largest discount in over 20 years.  While diversified portfolios have struggled over the past year, we believe diversification will pay off especially if market volatility increases as investors seek to own those portions of the market that are cheaper and may have less room to fall, compared to growth stocks.

The yield on the 10-year Treasury briefly eclipsed 5% in October.  We continue to believe that high quality intermediate term bonds look attractive.  Rates would likely move lower should we experience a recession in the upcoming year. If you own a 5-year bond that is earning 5% and interest rates go down 1%, that bond could provide the investor with a solid double-digit return. 

What has worked in the recent past is usually not what continues to perform well in the future.  We believe owning a diversified portfolio that includes value stocks, international stocks and intermediate term bonds may finally shine over the next few years as investors pay more attention to valuations and the economy and inflation cool.

Over the long run, a diversified portfolio tends to protect investors from the tricks of the market and helps them reach their goals, which is the biggest treat of all.