Monthly Market Update – September 2023

Key Points

• Yields Rise Sharply The big story for capital markets in September was the steady march higher in government bond yields, particularly those at the long end of the curve. The benchmark 10-year U.S. Treasury yield saw the sharpest monthly rise since September of last year. The 30-year U.S. Treasury yield had its largest monthly gain since April 2022 and hit its highest levels since 2011.
• Oil Prices Surge WTI Crude Oil prices surged +9% in September and nearly +30% for the third quarter from concerns over OPEC production cuts and decades low inventory in the Strategic Petroleum Reserves (SPR).  At the September price levels, it would be more expensive to replenish the SPR versus the last time the U.S. emptied the majority of its oil reserves. Higher oil prices also make it more difficult for the Fed to tame inflation.   
• U.S. Dollar Spikes Higher It was only a few months ago that many headlines were declaring that the U.S. dollar would be threatened by China and the other BRIC countries (Brazil, Russia, India). But since the summer months, the U.S. dollar has climbed to its highest level since November 2022, advancing close to +4%, one of the strongest 3-month periods since the 1970s. Unusually strong dollar rallies have typically challenged equity markets in the past.
• Budget Deficit Swells The budget deficit has increased sharply this year, much more than forecasted. As a result, it is pressuring long-term U.S. Treasury yields higher. To fund the deficit, the U.S. issues Treasuries. However, foreign buyers of that Treasury issuance (particularly China, Japan, and Saudi Arabia) are demanding higher yields to buy them – keeping upward pressure on them—in addition to the Fed’s hawkish monetary policy.
• Seasonality Improves We just completed the worst month of the year historically for U.S. equities. And combined with August, it was the worst two-month period historically. As a result, the third quarter has easily been the worst-performing quarter of the year. As we enter October, we say goodbye to those two worst months and the worst quarter of the year and welcome, seasonally over time, the best quarter of the year.

Market Summary

Asset Class Total Returns

Source: Bloomberg, as of September 30, 2023. Performance figures are index total returns: US Bonds (Barclays US Aggregate Bond TR), US High Yield (Barclays US HY 2% Issuer-Capped TR), International Bonds (Barclays Global Aggregate ex USD TR), Large Caps (S&P 500 TR), Small Caps (Russell 2000 TR), Developed Markets (MSCI EAFE NR USD), Emerging Markets (MSCI EM NR USD), Real Estate (FTSE NAREIT All Equity REITS TR).

To the displeasure of investors in virtually every asset class, September followed its historical trend of being the weakest month of the year. And following August’s negative performance, all major asset classes experienced their first back-to-back down months of the year. For diversified investors, it also resulted in the first negative quarter of the year after healthy gains in the first two quarters. Most diversified moderate-risk portfolios (i.e., 60% equity / 40% bond) are still up 3% – 4% in 2023, a whole lot better than the double-digit losses most experienced in 2022. 

The big story for capital markets in September was the steady march higher in government bond yields, particularly those at the long end of the curve. The benchmark 10-year U.S. Treasury yield was up +46 basis points (bps, or +0.46 percentage points) for the month, the sharpest monthly rise since September of last year. It was the fifth straight month of gains for the 10-year yield, putting it at 4.57% at the close of the month, which was the highest level since the fall of 2007. In contrast to much of the year, in which shorter maturities were rising the most, in September, yields with the longer maturities had the sharpest gains. The 30-year U.S. Treasury yield was up +49bps in September, its largest monthly gain since April 2022. At 4.70% at the end of September, the 30-year was at levels last seen in 2011.

Inflation has come down meaningfully since peaking last summer, and the Federal Reserve didn’t hike rates at its September meeting – although most voting members did indicate another hike might be necessary. So, with the Fed on pause and likely near the end of their hiking campaign, why did yields spike in September? Well, the balance of economic data during the month didn’t do much to help, with generally weaker-than-expected results for the majority of high-frequency indicators. Particularly concerning were drops in measures of consumer confidence—consumers spending has been quite resilient for much of the year. High-profile, large-scale labor strikes are also weighing on investors as the UAW union strike expanded through the end of the month. Of course, the politicians couldn’t help but add to the monthly malaise with yet another government shutdown showdown. It was temporarily resolved after a surprise deal was struck over the weekend – but that came after trading for the month had concluded. Other headwinds included WTI Crude Oil prices spiking +9% in the month (and nearly +30% for the third quarter) and the U.S. dollar jumping +2.5% in September. Another factor pushing yields higher is the U.S. budget deficit. It has also accelerated more than anticipated and is funded by the U.S. issuing Treasuries. However, foreign buyers of that Treasury issuance (particularly China, Japan, and Saudi Arabia) are demanding higher yields. That is discussed in more detail below in the “Budget Deficits Swell” section.

Needless to say, all those headwinds in September challenged investor confidence. The S&P 500 Index fell -4.9%, the worst month for U.S. large cap stocks since dropping -5.9% in December. It was the first back-to-back monthly losses for the S&P since August and September of last year – and only the third monthly losses of 2023. Likewise, the technology-heavy Nasdaq Composite Index had its first two-month losing streak since last August/September, dropping -5.8% last month. The real pain has been among small cap stocks, with the Russell 2000 Index sinking -6.0% in September, its sixth negative month in 2023, taking it to its lowest level since early June. Non-U.S. stocks fared better but were still in the red. Developed Market international stocks (MSCI EAFE Index) lost -3.7% in September. It was the biggest month of outperformance for developed international stocks over U.S. stocks since January. Emerging Market stocks (MSCI Emerging Markets Index) slipped -2.8% for the month. 

Bond prices, which move in the opposite direction of yields, slumped in September. The Bloomberg Aggregate U.S. Bond Index dropped -2.5% for the month in August, marking its fourth straight negative month and worst single month since February. International bonds (the Bloomberg Aggregate Global Bond Index ex U.S.) fared worse, sinking -3.3% for the month. U.S. and international bonds are now down for the year, with losses of -1.2% and -3.2%, respectively, for 2023 through September.

Fortunately, it is a new month and quarter, and hopefully, the poor showings in August and September are behind us. The last two months showed that the tailwinds from Covid stimulus are waning, and the headwinds from higher rates are starting to be felt. Still, the economy remains resilient, and earnings look like they have stabilized—Q2-2023 earnings were better than expected, and analysts’ revisions have turned positive for forward earnings. Markets are likely to remain choppy as they digest the Fed’s “higher for longer” hawkish rhetoric and the economy attempts to normalize at the elevated rate levels. The economy should continue to grow at a moderate pace, and the Fed is likely at, or near, the end of its rate-hiking campaign. Seasonality also gets much more favorable, as the historically worst performing quarter is behind us, and the best performing quarter—the fourth quarter—begins.

Source: Bloomberg, as of September 30, 2023.
Price Returns for Equity, Total Returns for Bonds.
* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Quick Takes

YIELDS RISE SHARPLY

Inflationary pressures mostly continued to moderate in September, and we are likely nearing a peak in the global rate-hiking cycle. So why have long-term yields shot so much higher in so little time? For one, markets are finally heeding the Fed’s message that rates will remain “higher for longer.” Additionally, markets have begun to focus on the fiscal health of the U.S. as budget deficits have swelled far more than forecast, and political wrangling becomes more dysfunctional. As a result, the U.S. will need to issue more Treasurys to fund the larger-than-expected deficits, and the countries that are buying that U.S. debt are demanding higher yields for it. Back in April, Goldman Sachs projected this year’s budget deficit to be $1.6 trillion—no small amount. But it actually came in much higher than that, at $2 trillion, and would have been $2.3 trillion if the Supreme Court had not canceled the Biden Administration’s student loan forgiveness plan. With more than 50% of the U.S.’s outstanding debt maturing in the next three years and no end in sight to the political brinkmanship in dealing with it, the upward pressure on long-term bond yields may persist. That’s not really the Fed’s problem, but in reality, it will have to deal with the economic implications of that upward pressure on yields, which reinforces the “higher for longer” policy stance. For instance, the average rate on the standard 30-year fixed mortgage jumped to 7.31%, according to a survey of lenders released last week by mortgage finance giant Freddie Mac. That was the highest level since December 2000.

Long Bonds to Short Bonds: Hold My Beer

Long-Dated Bonds Narrowed the Yield Gap with Short-Dated Bonds in September

Source: Bloomberg.

OIL PRICES SPIKE HIGHER

WTI Crude Oil prices spiked +9% in September and nearly +30% for the third quarter, reaching their highest level since August 2022. Rising concerns over OPEC production cuts and decades-low inventory in the Strategic Petroleum Reserves (SPR) stocks helped fuel the rise. At the September 2023 price levels, it would be even more expensive to replenish the SPR versus the last time the U.S. emptied the majority of its oil reserves. This time around, U.S. reserves are nearly 250 million barrels emptier, their lowest since 1983. Therefore, refilling reserves above $90/bbl would be more expensive than what the same reserves sold for a year ago. However, in the first week of October, crude oil has dropped nearly -$10/bbl, which greatly improves the SPR math.  

Oil Prices are at their Highest Level Since August 2022

Source: Bloomberg. Data as of 9/30/2023.

U.S. DOLLAR SURGES

The U.S. Dollar Index, a measure of the U.S. dollar against six leading global currencies, climbed to its highest level since November 2022 in the early days of October. Over the last three months, it has risen close to +4%, which puts it in the 8th percentile of all three-month periods since the 1970s. Larger-than-usual dollar rallies lead to lower-than-average equity returns. As long as the dollar is ascending, the equity market will be challenged to make a sustained move higher.

The US Dollar Index is at its Highest Level Since November 2022

Source: Bloomberg. Data as of 9/30/2023.

BUDGET DEFICIT SWELLS

A sharp increase in the U.S. budget deficit is pressuring long-term U.S. Treasury yields higher. Back in April, Goldman Sachs projected the 2023 budget deficit to be $1.6 trillion—no small sum. But the budget deficit actually came in at $2 trillion and would have been $2.3 trillion if the Supreme Court didn’t cancel the Biden Administration’s student loan forgiveness plan. That’s a doubling of the level from last year and now comprises 7.4% of GDP—the largest non-emergency deficit that the U.S. has ever run. According to the Center for American Progress, we need to stay below 2.4% of GDP to keep the debt load from continuing to grow.  To fund the deficit, the U.S. issues Treasuries. However, foreign buyers of that Treasury issuance (particularly China, Japan, and Saudi Arabia) are demanding higher yields. And in the current political climate, reducing the deficit is likely to be even harder than it has been to reduce inflation.

Deficit Swells to $2.0 Trillion Over Past Year

Source: Committee for a Responsible Federal Budget, U.S. Department of Treasury, Congressional Budget Office.

PRICE OF ADMISSION

Over the past 30 years, the S&P 500 has experienced an average of three to four pullbacks of -5% or worse per year. Pullbacks in the markets never feel pleasant, but they are the cost of admission to achieving the attractive long-term returns that the equity markets provide in order to attain our long-term financial goals. So far, these pullbacks fall in the “routine” category. Since 1950, the average length of a -5% or more pullback that doesn’t turn into a -10% or worse correction lasts about 43 days. The February/March pullback was 26 days long and recovered in 47 days. The current pullback is just at the 43 day average as of publication.

Just the second S&P 500 Pullback (-5%) in 2023

Source: Bloomberg. Data as of 9/30/2023.

GOOD RIDDANCE—SEPTEMBER SEASONALITY OVER

Seasonality has been a headwind for the last couple of months, particularly September, which historically has been the weakest month of the year. As we discussed at the end of the summer, August is also typically a challenging month relative to the others. With August and September making up the bulk of the third calendar quarter, it isn’t a surprise that historically, Q3 has been the weakest quarter of the year. As shown in the chart below, in the post-World War II period, the market is entering what has historically been its strongest quarter of the year. In the post-WWII period, the S&P 500’s average performance in Q4 has been a gain of +4.1%, which is more than double the +2.0% average gains of Q1 and Q2 and ten times the average gain of Q3 (+0.4%). The big caveat is that this is simply historical seasonality, not an investment strategy or a fundamental thesis. Still, it’s nice to have better odds on the market’s for the next few months.

Seasonality Improves After September

S&P 500 Quarterly Performance (1945-2022)

Source: Bespoke Investment Group.

Asset Class Performance

The Importance of Diversification. Diversification mitigates the risk of relying on any single investment. It offers many long-term benefits, such as lowering portfolio volatility, improving risk-adjusted returns, and helping investments to compound more effectively.

Source: Bloomberg.
Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by The Retirement Planning Group. The performance of those funds may be substantially different from the performance of the broad asset classes and to proxy ETFs represented here. US Bonds (iShares Core US Aggregate Bond ETF); High‐Yield Bond (iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares US Real Estate ETF). The return displayed as “Allocation” is a weighted average of the ETF proxies shown as represented by: 30% US Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4% Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.
* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Chris Bouffard is CIO of The Retirement Planning Group (TRPG), a Registered Investment Adviser. He has oversight of investments for the advisory services offered through TRPG.

Disclaimer: Information provided is for educational purposes only and does not constitute investment, legal or tax advice. All examples are hypothetical and for illustrative purposes only. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. Please contact TRPG for more complete information based on your personal circumstances and to obtain personal individual investment advice.