BY: RYAN P. JOHNSON, CFA, CFP® - MANAGING DIRECTOR OF INVESTMENTS
Stocks continue to be driven by interest rate changes, which are being driven by Fed commentary, which is being driven by inflation readings, which depends on the strength of the economy. Recent readings show economic strength and earnings at the S&P 500 level may be positive in the third quarter after several quarters of year-over-year declines. Treasury yields hit new multi-year highs, even though the Fed may be less likely to raise rates again.
The Federal Reserve recently shifted their messaging, indicating that recent increases in medium-term and long-term interest rates are restricting economic growth, which lessens the need for the Fed to raise their short-term rates any further. It is increasingly likely that the Fed is done raising interest rates this cycle, with their last hike in the rearview mirror in late July. While the Fed is still expected to keep rates higher for longer, we feel that taking interest rates hikes off the table was a positive for risk assets like stocks.
Yields on Treasury bonds with maturities from 2 years to 30 years are all around 5%, which we would describe as flat yield curve. In the past three months, the interest rate on 5-year, 10-year, and 30-year Treasuries have increased from ~4% to ~5%. As interest rates rose, bond prices fell. As of this writing, the year-to-date return of the U.S. Aggregate Bond Index (which includes Treasuries, mortgage-backed bonds, and corporate bonds) was -3.4%. That loss was comprised of a negative -5.5% price return, but positive 2.1% interest received. If the total return stays negative through year-end, it would be a very rare third year in a row with a loss.
Continued strong U.S. employment has kept recession worries at bay. Several historical indicators of recession, such as an inverted yield curve, a contraction in the manufacturing segment of the economy, and declining corporate profits have yet to translate into a contraction in the economy. The services segment of the economy is larger than in years past, and that area of the economy remains in growth territory. Core inflation readings have generally headed in the right direction and consumer spending in September was stronger than expected. Still, higher oil prices and higher loan costs will have an impact. Even so, consumer spending this holiday season is expected to grow.
Since our last Insights, stocks fell, then rose, then declined again. Rising interest rates from mid-September to early October put pressure on stocks. Around the time the Fed signaled no imminent rate hikes, stocks rose from multi-month lows. Stocks then retreated as interest rates rose and volatility increased. The S&P 500 remains about 7% below the 2023 peak seen in late July. The next two weeks will be heavy with Q3 corporate earnings reports and some Q4 guidance. Unlike the past three quarters, Q3 corporate earnings for the S&P 500 in total are expected to grow, but very slightly. Q4 earnings are also expected to grow, and full-year earnings may be positive for 2023.
What is a wash sale and does it apply to gains? A wash sale occurs if an investor sells an asset for a loss and, within 30 days before or after, purchases a substantially identical asset. The loss is not allowed for current income taxes and a cost basis adjustment may be applied to the newly purchased asset. In essence, this prevents a taxpayer from receiving the benefit of recognizing a tax loss while still being able to own that asset. However, if an investor has a gain, the gain can be realized with a sale and the asset can be immediately repurchased. This will result in a new, higher cost basis and this is not a wash sale. Tax loss harvesting and tax gain recognition are tools our advisors use in multi-year tax planning when considering all sources of income, retirement planning, Medicare premiums, and more.
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Ryan P. Johnson, CFA, CFP®
Managing Director of Investments
RISKS AND IMPORTANT CONSIDERATIONS
Views and opinions expressed here are for informational and educational purposes only and may change at any time based on market or other conditions or may not come to pass. This material is not a solicitation to buy or sell securities and should not be considered specific legal, investment, or tax advice. The information provided does not consider the objectives, financial situation, or needs of any specific individual. All investments carry a degree of risk and there is no certainty that an investment will provide positive performance over any stated period. Equity investments are subject to company specific and market risks. Equities may decline in response to adverse company news, industry developments, or economic data. Fixed income securities are subject to market, credit, and interest rate risks. As interest rates rise, bond prices may fall. Past performance is no guarantee of future results.