Stocks and bonds continued their 2023 recovery in June from the dismal results of 2022. Broad-based US stocks rose 16% through the end of June, while developed country stocks increased 11% and emerging markets stocks were up 5%. The tech-heavy NASDAQ index climbed almost 32% through half of 2023.
Bonds also had positive returns through June 30. With the benchmark 10-year Treasury remaining relatively high at 3.81%, down slightly from 3.88% at the beginning of the year, income has increased while prices have remained stable. US bonds rose 2.6% in the first half of 2023, while high-yield bonds increased 4.4% and inflation-protected bonds were up 1.8%.
Interest rate increases by central banks around the world, attempting to contain inflation without causing recession, remain among the most closely watched economic indicators. The US Federal Reserve is focused on engineering a “soft landing” from the historic inflation in 2022, but opinions differ as to whether that will happen.
As Talmon Joseph Smith writes in The New York Times, “For a year or more, worries about an impending recession have dominated discussions about the economy. Most economists expected a recession to hit the US by now – in part because of the rapid escalation of interest rates. That increase in the cost of credit has caused shocks in the banking sector and, for a while, put a lid on the housing market.
“But the dampening effect of higher rates has confronted the robust income and spending of many households and the staying power of businesses – both buttressed by emergency pandemic support from Congress and the Fed. Though families, business managers and investors alike have had to contend with the frustrating realities of inflation and economic uncertainty, growth has continued, almost defiantly.”
“[But] a growing cohort of investors believes that sustained growth could plant the seeds of its own destruction, as the Fed reacts by keeping borrowing costs higher for much longer than businesses have anticipated. That could make some debt burdens unsustainable for businesses, especially those that rely on loans or lines of credit from banks or that may need to seek new funding from investors.”
Matt Grossman, writing in The Wall Street Journal, suggests the possibility that rates need to be even higher than they are now, possibly beyond the one or two additional rate increases expected from the Fed later this year:
“Investors generally expect higher interest rates to cool the economy, as part of the process known broadly on Wall Street as “tightening financial conditions”—a constellation of higher mortgage rates, rising bond yields and generally lower asset prices. Together, these factors tend to reduce the amount of money coursing through markets, for instance by making it harder for people and businesses to get loans.
“But one complication is that it is hard to know in real time whether conditions are actually tight or whether they just look that way, particularly when inflation… hit its highest level since the early 1980s.
“Understanding whether financial conditions are tight or loose is challenging because a key variable is hidden from view, economists say. What matters isn’t the absolute level of the Fed’s target rate, but rather whether it is higher or lower than a hypothetical “natural” rate that would neither slow nor stimulate the economy.
“Economists say that financial conditions only tighten when market interest rates rise firmly above the natural rate. The natural rate can’t be measured directly, and it changes over time—rising when demographic or technological changes improve the economic outlook, and falling when underlying prospects dim. If it has risen considerably over the past two years, it is plausible that the Fed hasn’t tightened monetary policy as severely as its dramatic rate-hike campaign would suggest.
“Scott Sumner, a monetary economist who recently retired from George Mason University, thinks that the natural rate has climbed sharply—pushed higher by the Fed’s monetary stimulus during the pandemic—muting the effects of the Fed’s 5-percentage points of rate increases over the last 18 months.
“’Most people would interpret higher rates as tighter policy, but you can’t necessarily jump to that conclusion,’ Sumner said. ‘If it were truly a tight monetary policy, I’d expect stocks to be depressed.’”
As always, we will continue to monitor the markets, but still recommend a long-term perspective with diversified allocations to stocks and bonds based on your specific financial situation.
One other important recent piece came from Jeff Sommer in The New York Times. He discusses the current attractiveness of bonds and cash, even as the stock market has made a strong recovery so far in 2023:
“Amid all the hoopla [surrounding a possible Artificial Intelligence-driven stock bull market], you can easily miss the solid returns being posted by far less glamorous but always important and, at the moment, compelling asset classes: fixed income investments, including bonds and cash.” [PPA note: The highest-yielding cash investments these days are referred to as “purchased” money markets funds.]
“Especially for those with short time horizons – whether you’re in retirement or close to it, or saving for a house, education, a car, a vacation or any other worthwhile purpose – those lower-risk investments are worth a close look. They provide solid income with much less risk than stocks – in theory, anyway.”
After a terrible 2022 for bonds, when prices declined in the range of 15%, “bonds are more reliable than they were last year because yields are already high. Even if they elevate further, there is a plush cushion now, and any potential price declines should be offset, and then some, by the income that bonds are generating.”
Please don’t hesitate to let us know if you’d like to discuss these or any other topics in additional detail.