Third Quarter Market Update: Seasons of Change
For sports lovers, this is a great time of year given the overlap of baseball and football, so a super fan can enjoy a full weekend of games without ever leaving the sofa. One observation about this baseball season has been the number of strong teams that will be competing in the playoffs. Normally, there are one or two standouts, but this year, it seems like there are quite a few teams that could ultimately win the Championship. The St. Louis Cardinals are certainly one of those teams. They had the third longest winning streak (17 straight wins) of any Major League Baseball team in the last 50 years; however, there are nine other teams with better records than the Cardinals. This brings up a question that is very relevant for investors: Would you rather have “streaky” performance or “consistent” performance? I think most would agree that consistency is preferred.
As we transition from Summer to Fall, it is interesting to consider the similarities in the “seasonality” of the markets and the economy. The recovery since April 2020 has been remarkable, with strong job growth and corporate profits. Now, as we move from early economic cycle to mid-cycle, the dynamics begin to change. Economic growth and interest rates may start to normalize towards historical levels, and those asset classes that have performed the best coming out of the recession may not be the ones that do well during the next phase.
When we evaluate the current landscape, the positives and negatives are somewhat in balance. Among the headwinds are the impact of variants of COVID-19 spreading through parts of the U.S., as well as rising inflation caused by supply-chain issues. Other challenges revolve around monetary and fiscal policy, including possible tax increases, the status of the infrastructure proposals and some potential turnover in Federal Reserve leadership. On the other hand, there are reasons for continued optimism: interest rates remain low, housing is strong and most publicly-traded companies are financially sound. While valuations are higher than normal, corporate earnings growth and lower bond yields have mitigated this concern to some extent.
Over the last few years, the markets have been led by a handful of technology and consumer-oriented companies that have performed extremely well. Looking back in history, this type of market concentration is not necessarily a rare occurrence; however, a well-diversified portfolio tends to do a better job of achieving financial goals over long periods of time with less volatility and delivering a more consistent investing experience. Many decades of data have shown that there is a return premium for “value” stocks and “smaller” company stocks. While this premium may not be evident year-in and year-out, it becomes apparent over long time horizons. As patient advisors, we include these types of strategies in our portfolio allocations, along with other investing styles that have stood the test of time.
In terms of performance, the U.S. stock market, as measured by the Russell 1000 Index, generated a small quarterly return of 0.2%. This index had delivered positive results every month since January, but that streak was snapped in September, when it declined by 4.6%. U.S. mid cap stocks and small cap stocks declined by 0.9% and 4.4%, respectively, for the last three months, while the MSCI All Country World Index (which includes stocks outside of the U.S.) dropped 3.0%. Despite interest rates moving higher at the end of the quarter, the Bloomberg US Aggregate Bond index was up slightly (+0.1%).
In closing, we know that Fall weather can be temperamental – some days will be sunny and mild, while other days will be rainy and cold. This same description is true of the markets. Surprisingly, daily movements in stocks are almost as likely to be negative (47% of the time) as positive (53% of the time); however, extending the time horizon to one year, three years and five years (and beyond) significantly increases the odds of investor success. The keys to achieving long-term goals are patience, discipline and being able to tune out the noise, not unlike what a quarterback must do in a stadium full of boisterous fans.
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