Review & Outlook
October 11, 2023
After a positive month in July, the Stock Market gave back its gains and then some over the last few weeks as interest rates rose to levels not seen since the Great Financial Crisis in 2008. With mortgage rates above 7% and Oil prices climbing 15% during the quarter in conjunction with employment gains and solid consumer spending, investors continue to worry about the Federal Reserve keeping interest rates higher for much longer than expected just a few short months ago. As a result, both stock and bond values fell during the period.
Since the Federal Reserve started raising rates in 2022 off a zero-bound level, the magnitude and speed of this interest rate cycle has been unprecedented. As a result, an extremely narrow range of Stocks has kept markets afloat. The largest seven companies measured by market capitalization have averaged a year-to-date total return of 92%, while the remaining 493 Stocks in the S&P 500 Index averaged only 0.1% for the same period. Therefore, Carderock’s Quality Growth stocks unsurprisingly have continued to underperform. And while many of our holdings have broadly been shunned during this high inflationary period, we believe market breadth and diversified portfolios will come back in favor as downtrodden sectors rebound, interest rates stabilize and wage growth moderates.
In our view, “Growth with low inflation” is not out of reach heading into 2024 as Labor markets remain strong, Capital spending has boosted our long dormant industrial sector and China’s slowing economy should keep prices subdued. While structural challenges remain in the U.S., we are optimistic that the benefits of current capital investment will accrue throughout the economy, and to our Quality Growth companies as well.
Our recent activity can be summarized accordingly:
- Cash reserve targets stand at 12.5% – close to historical norms and inside our Risk Management midpoint.
- Stocks purchases have brought Cash Reserves down from nearly 40% in 2022.
- We have added new names in the Healthcare and Industrial sectors, as we see a turnaround starting to form.
- We continue to vigilantly allocate excess cash into Treasury bills with short-term rates remaining attractive.
For the remainder of the year and beyond, we are focused on and will respond accordingly to the following factors:
- Stocks generally fare well following the last Federal Reserve rate hike.
- Current selloffs represent attractive buying opportunities.
- Economic growth continues unabated despite the Federal Reserve’s best efforts at slowing things down.
- Broad unionization has put a floor underneath Labor, making it unlikely high interest rates will lead to higher unemployment.
- Investment in capital intensive, productivity enhancing projects will take precedent over financial engineering (e.g., stock buybacks, speculation and IPOs) to enhance shareholder value.
- The narrative on Artificial Intelligence has been the primary driver of Stocks in 2023, but its promise of enhancing profitability is unproven thus far.
Finally, we highly encourage you to view your 2023 realized capital gains shown on page two in the report section or on your Schwab monthly statement. On average, these gains are much less compared to 2022 which may affect your 4th Quarter estimated tax payment. Please check with your tax advisor to confirm.
As always, feel free to call us to discuss any changes in your circumstances, or any needs or questions you may have.
Warmest Regards,
Daniel A. Kane, CFA
President
James W. Mersereau, CFA
Portfolio Manager
Stephen F. Knapp, CFA
Director of Research
