The Quarter in Review

Notable events this quarter

• JULOil moved back above $100 a barrel as fighting between the U.S. and Iran resumed in July.
• AUGThe S&P 500 hit a record high in August, and as I write this it has set new highs again in October.
• SEP 16The Fed raised interest rates on September 16 — its first increase in more than three years — with inflation running at 3.4%.³
• Q3The 10-year Treasury yield climbed to 5.3%, its highest level since 2007, and bonds had a difficult quarter as a result. That feels high after a decade of unusually low rates, but historically it’s close to normal for the U.S.⁴

01

What happened to my bonds?

If you noticed the bond side of your portfolio lost ground this quarter, you aren’t imagining it. The broad U.S. bond market fell about 3.5% and municipal bonds about 6% as yields jumped. Here is the context that matters: rates went up because the economy is strong, not because something is breaking. Rising yields hurt bond prices today, but they also mean your bond income is now higher than it has been in years — a 10-year Treasury pays over 5%, and cash pays around 4%. Some clients have asked whether it makes sense to simply sit in cash. For money you’ll need in the next year or two, yes, and your allocation already provides for that. For the rest, remember that cash has earned under 3% so far this year while diversified stocks earned roughly four times that.⁵ Cash is a place to wait, not a place to grow.

02

Why is the economy strong enough for a rate hike?

Two reasons. First, American companies are spending an estimated $800 billion this year building out artificial intelligence — data centers, chips, and the electricity to run them. Second, the consumer is holding up: employers added 162,000 jobs in August, unemployment is 4.1%, wages are rising faster than prices, and consumer spending set a record. Capital Group’s economists believe the U.S. could grow 2.5–3% this year, well ahead of the rest of the developed world.⁶ The risk is that so much of that growth rests on a single theme. That’s why, after a strong run in AI and semiconductor stocks, we recently took some profits from the funds that hold the most of them.

03

The world still runs on oil

The conflict with Iran is a reminder that about one-fifth of the world’s oil passes through the Strait of Hormuz, and every flare-up shows up at the gas pump within days. Gasoline futures have more than doubled this year. Markets, however, have seen this movie before. Across seven oil-supply shocks since 1990, stocks on average dipped about 1% in the first two weeks and were up 12% a year later. We don’t dismiss the risk; we just don’t let it dictate your allocation. Our commodity positions also traded places this quarter: gold, last year’s star, gave back about 6% in September and is slightly negative for the year, while Bitcoin, after a rough first half, rebounded more than 40%.⁷ We sized both for patience, and after Bitcoin’s rebound we trimmed it back to its target weight.

04

Looking ahead

Midterm elections are November 3. History says midterm years bring volatility and muted returns before Election Day, then stronger returns afterward — the S&P 500 has averaged about 15% in the twelve months following a midterm since 1950.⁸ We will plan rather than predict. As always, we continue to rebalance. In early October that meant trimming what had run and adding to bonds and to small and mid-sized companies, which lagged this quarter. Rising markets tempt us to add risk, and rough patches tempt us to cut it; your allocation was built to resist both. For our tax clients, we’ll also be reviewing year-end opportunities such as tax-loss harvesting, charitable giving, and other ways to keep more of what you’ve earned. We are grateful for your trust and for the opportunity to serve you.