Quarterly Update

US and global stock markets performed well for much of the summer before faltering just prior to the end of the third quarter (Q3). Investor confidence took a step back as prices fell and volatility rose. The downward slide was due to a host of issues that festered throughout Q3 but remained unresolved as the calendar shifted quarters.

Here’s a roundup of how major markets performed during the third quarter and year-to-date, respectively:

• US Large Cap Stocks: up 0.6%, up 15.9%
• US Small Cap Stocks: down 4.3%, up 12.3%
• US Core Bonds: basically flat, down 1.7%
• Developed Foreign Markets: down 1.1%, up 8.4%
• Emerging Markets: down 8.7%, down 2.1%

September has historically been one of the worst months for stocks. According to Bespoke Investment Group, the past 20 years has only seen positive returns 38% of the time for the S&P 500 during September. Add in a long period of low volatility mixed with a waning-but-still-concerning Delta variant, a potential government shutdown and debt default, trillions of potential new spending from Congress, and then a looming “Lehman Moment” coming out of China late in the month, and it’s no surprise we saw a rocky September.

Across sectors, the Financials and Utilities sectors fared best for Q3 as a whole, while Industrials and Materials performed the worst. But during September Energy was up almost 9% while the other major sectors finished in the red, with most down 5% to 7%. Developed foreign markets followed suit, down about a percent for the quarter and about 3% during September. The main emerging markets index was down almost 9% for Q3 and about 4% for September on concerns emanating primarily from China, Hong Kong, and Brazil.

While the surge in volatility was due to many factors coming together seemingly all at once, one of them, inflation, has been of growing concern at least since the pandemic lows in 2020. Since then the Federal Reserve has pumped trillions of dollars into the financial system to help support the economy and markets. Congress added its own cash as well. This spending was meant to be inflationary but controllable, or at least short-lived. We seemed to reach a point of consternation when inflation numbers through August showed prices rising by 5.3%, a number not seen for at least a decade. In response, the Fed continued to profess being relatively unconcerned about rising prices and reiterated it can move to control inflation if needed.

Along those lines, bonds were volatile during Q3, although the changes were small when compared to the stock market. The yield on the 10yr Treasury, a major benchmark, began the quarter at about 1.4%, then sank to almost 1% before reaching about 1.5% at quarter’s end. These moves kept major bond indexes about flat for the quarter. Longer-term bonds were negative.

Another factor causing market volatility was growing tension around the debt ceiling, an arbitrary limit Congress sets for our nation’s borrowing that has been around for over 100 years. Since then it’s never been reduced, only extended many times, and sometimes temporarily suspended as it was last year. This year Congress has to raise it or risk running out of room to borrow to pay government debts. The latter would mean “default” and is very similar to a household running out of available credit as the bills keep coming due. But since the federal government can always create more money where households can’t, debt ceiling debates are essentially an opportunity for political theater that moves markets and scares a lot of people unnecessarily. The rhetoric picked up steam late in September, but the issue was left unresolved as the quarter ended.

Investors also focused on spending plans in Congress. There was short-lived concern that the government would be forced to shut down at the end of September, but that risk was pushed off until December. Congress also left in the air multi-trillion-dollar spending packages that would alter the tax code, retirement savings, and personal banking, just to name a few areas that would be of direct concern to investors. While more spending would certainly benefit the economy in the short- and medium-term, as the quarter waned investors grew uneasy about what the final bills might contain and how these provisions would play out in the real economy.

But people in the real economy seem to be doing pretty well, at least on average. According to government statistics consumers have more cash in the bank, more home equity, and less consumer debt than before the Great Recession. Rising stock prices and a hot housing market and have helped folks who hold these assets feel the so-called wealth effect which increases confidence. And government subsidies have helped those who don’t (as well as many who do) shore up their personal balance sheets. In short, there’s still a lot of spending money out there and this should help keep the economy growing.

This continued growth is expected to be a tailwind for the stock market as we enter the fourth quarter. And just as September is often a bad month for stocks, the winter months are usually good. I wouldn’t expect a cakewalk, however. Volatility is likely to be with us for awhile as we work through the variety of issues alluded to above.

Have questions? Ask me. I can help.