“The Higher-for-Longer Market: Resetting Expectations for Q4 2023 – Buckle up for a prolonged period of growth as the market defies expectations and continues to soar, challenging investors to reevaluate their strategies for long-term success.”
The consumer is taking center stage in the fourth quarter as the holiday shopping season approaches. This is particularly relevant as the market adjusts to higher interest rates. Despite the challenges, consumers have shown remarkable resilience this year, driving better-than-expected economic growth. However, there are signs of slowdown, with payroll growth slowing and savings cushions dwindling. Higher credit card rates are also squeezing budgets. The dependability of consumers is being tested as everyone adjusts to the new normal in interest rates.
Inflation remains a headwind, although the risk has moderated. While improvements in supply chains and lower demand for goods have helped bring inflation down, it is expected to stay above the Fed’s target of 2% through the winter. High demand for services continues to put upward pressure on prices, and recent geopolitical events have added some risk of higher energy prices.
The market has finally accepted the Fed’s higher-for-longer stance on rates, with the expectation that rates won’t drop until at least 2024. The third quarter saw a rapid sell-off in bonds as the markets adjusted to the end of accommodative rate policies. Yields soared before tapering off, but they remain historically elevated. This reset in expectations has been necessary, as historically, higher interest rates have not hindered solid stock performance.
The higher rates and yields have brought some parity to asset allocation, making bonds more attractive relative to equities. This has put downward pressure on stock prices, and stocks will need yields to level off before a significant rally can unfold. However, there is compelling value in both fixed income and equity for investors with longer time horizons. Those who remain focused on quality and balanced in their approach to risk can find plenty of opportunity in a higher-rate environment.
For fixed-income investors, there may be an opportunity to buy treasury bonds or fixed-income ETFs and mutual funds if yields start to level off. However, investors should be aware of the risks, including the possibility of the Fed remaining hawkish and continuing to raise rates, as well as the default risk in the high-yield bond market. A more conservative approach would be to invest in quality issues and spread risk across durations.
In the equity market, some valuations are no longer cheap, but certain sectors still offer opportunities. Buying and holding disciplined, proven companies with strong balance sheets and consistent dividends can help temper short-term risks. Financials and the energy sector can perform well in higher interest-rate environments, while consumer staples may begin to outperform consumer discretionary as inflation and higher borrowing rates impact consumer spending.
Investors need to keep a close eye on geopolitical events, particularly in the Middle East, as they can impact oil prices and energy costs. Higher inflation resulting from these events could make the Federal Reserve even more hawkish. It is a time for investors to be careful but not fearful, considering their investment time horizon and seeking attractive risk/reward profiles in higher-quality companies.
Disclaimer: The views and opinions expressed in this blog are those of the author and do not necessarily reflect those of Nasdaq, Inc.