From the Portfolio Management Team
The Financial Markets in the Third Quarter
As you can see in the chart below, the stock market started the quarter positively, returning around 3% in July alone. Then inflation fears became the theme for August and September, which led both the stock and bond markets to worry that the Federal Reserve would have to hold the Fed Funds rate higher for longer than previously anticipated. Prolonged, higher interest rates are feared by stock and bond investors, as prolonged high rates increase the likelihood of a recession and the market value of an existing bond goes down as interest rates go up. For the quarter, the S&P 500 and Nasdaq Composite were each down around 3.3% while the Bloomberg US Aggregate Bond Index was down 3.9%.
Taking A Step Back: The Markets So Far This Year
At the end of the third quarter, the year-to-date total return (including dividends) for the S&P 500 was 13.07%, the Nasdaq Composite was up 27.11%, and the Bloomberg US Aggregate Bond Index was down 1.21%.
But as we take a step back and analyze the returns, we see that the stock market has been driven by a small handful of companies. Dubbed "The Magnificent Seven," the top 7 companies in the S&P 500 are responsible for the vast majority of the year's price action—in other words, the other 493 stocks in the S&P 500 have collectively produced almost no return in 2023.
We apologize that our graphic below isn't the highest quality, but as long as you can see the colors then you can see the point. The thick black line (mostly along the top) is the price return for the S&P 500 for the first three quarters of 2023. The orangish color is the return for the "Magnificent Seven" while the gray color is the return for the remaining stocks in the index. In the financial industry, we refer to this as very low "market breadth"—another way of saying that the stock market is being dominated by a few companies as opposed to more broad participation by the nation's publicly traded companies.
The Economy in the Third Quarter
The U.S. economy was robust in the third quarter. Consumer spending held up, the manufacturing sector started to rebound from negative levels, labor markets continued to show resilience, and the services sector—the largest component of the U.S. economy—remained strong. In the graph below, you can see that economists (blue line) think the economy grew at around 3% in the quarter while the Atlanta Federal Reserve’s GDPNow number (green line) was almost 5%.
Strong economic growth is typically applauded, but too much growth leads to higher inflation. One of the worries Federal Reserve Chairman Jerome Powell has discussed is the notion of the “wage price spiral,” which is an economic term referring to the phenomenon of price increases being caused by higher wages; when workers receive a wage hike, they demand more goods and services and this, in turn, causes prices to rise. Data shows that the average wage of the US worker increased steadily throughout 2022 and although the rate of increase is slowing, wages are still growing at north of 5% (percent change from the prior year).
Looking Ahead
We live in complex times that are creating a confusing backdrop for investors. Throughout the year, we've navigated between stubborn inflation on one side and potential recession on the other, a strong housing market throughout most of the country, two narrowly-averted government shutdowns, low unemployment with continued wage increases, labor union strikes, resumption of student loan debt repayments (with continuing confusion and volatility around the topic), a hawkish Federal Reserve, long-term interest rates (including mortgages) soaring to levels not seen in over 15 years, increasing energy prices, frighteningly high government debt, and continued geopolitical tensions and conflicts.
So where do we go from here?
The only truthful answer is that we don't know. We are impressed by the economy's continued strength while keeping an eye on the many risks that could threaten that strength.
We continue to hold very diversified portfolios. Large, growth-oriented companies dominated the returns in portfolios so far this year, but we remain happy to hold dividend-paying, "value" positions as well as smaller sized companies. Beginning in July, we raised cash in all but our most aggressive (and therefore longest term) portfolio models—not to make a bearish call, but with the thought that we would like to take a slightly more defensive stance and have cash on the sidelines ready to deploy.
Quarterly Reports
Your third quarter 2023 portfolio reports have been uploaded to your CPWA client portal. If you don't recall your login and/or need your password reset then please email Meredith.
In Personal News
Meredith is eager to head to Oaxaca, Mexico with her husband in a few weeks to celebrate Dia de Muertos with the locals. She's also looking forward to sharing Thanksgiving with family at her sister's home in Seattle, where she will not only get to feast but will also play with her niece and nephews!
Dan and his wife enjoyed a trip to Barcelona over the summer. They also proudly watched their son, Colin, complete his commercial pilot's license while their son, Duncan, finished his third summer of internship in our office.
Brianna and her family are in the middle of calving season on their ranch and love watching the baby calves run around the pastures, kicking up their heels in the crisp morning air. She is also looking forward to a trip to Kauai with her husband, going back to the location they honeymooned six years ago.
Jenni and her family moved to a Cal Poly ranch in recent weeks and are still settling in. Her three boys are (finally!) attending the same school, and she is thrilled to have them all in the same location.
Lyle completed his backyard project and is looking forward to seeing his rapidly growing granddaughter (and her parents!) in person this weekend.
Thank You
As always, thank you. If you have questions about your portfolio, financial plan, or a related topic then please contact your primary advisor or our office. We wish you a wonderful final quarter of the year!
Cerro Pacific Wealth Advisors LLC is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Cerro Pacific Wealth Advisors LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Cerro Pacific Wealth Advisors LLC unless a client service agreement is in place.
