After a relatively strong start to the year, September was a sobering reminder that stock markets are heavily driven by changing expectations in the short run. Despite an improving outlook for US growth and a resilient job market, investors have suddenly become fearful at the prospective impact of interest rates staying higher for longer than previously anticipated. Perversely, a stronger economy now portends a weaker economy in the future. The US Fed will have to be more aggressive than originally expected to get inflation down to its target.
Taking a step back, we are still living the aftershocks of the pandemic fiscal and monetary stimulus. It will take time to find the new equilibrium as central banks soak up the excesses of the pandemic rescue packages. Central banks are diligently working to find the right balance and despite all the criticism, they are doing an admirable job of it.
September was a difficult month in stock markets as expectations of a future recession increased. But viewed in the longer-term context of an economy adjusting to more normal interest rates (that it has not experienced in decades), it is perhaps not as surprising that there have been and will be bumps in the road.
The benefits of this new equilibrium are many: Higher interest rates mean that investors are finally getting paid to hold bonds. The bonds in your portfolio now have a yield to maturity of 5%.1 As we observe the real return on bonds increasing (i.e., the nominal yield minus the rate of inflation), history suggests that should be accompanied by higher real returns on stocks too.2
Despite the recent downturn in stock markets, portfolios are still in positive territory for the year to September 30th, with returns varying from about 2.5% to 6.5% net of fees, depending on the risk level of the portfolio.
The returns provided from January 1st to September 30th of the markets represented in your portfolio were as follows3:
I always find it helpful to remember that over the last 20 years, the average intra-year drop in the US stock market has been about 15%. What we saw in September is a normal variation in the market, even if it is unsettling. Persisting through difficult markets is why investors in stock markets get paid more than bonds or cash.
I’d like to wish everyone a Happy Thanksgiving and a wonderful weekend with family and friends.
1 Source: Yield to Maturity on Vanguard Canadian Short Term Bond Index ETF and BMO Aggregate Bond Index ETF as of October 4, 2023
2 See Credit Suisse Global Investment Returns Yearbook 2023 Summary Edition, page 20
3 Source: PWL Market Statistics
