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Quarterly Perspectives: Q3 2023

Published October 11, 2023.



Hello, and welcome to Quarterly Perspectives third quarter 2023.

My name is Alex Kluesner, and I'm a member of the investment strategy team at Buckingham Wealth Partners.

I'll be your host for this presentation. 


This presentation details quarterly equity and fixed income performance along the framework of absolute returns, relative returns, and future expectations for market performance. 

Will then go on to discuss recent interest rate movements and inflation expectations.

Last, we'll examine how different asset classes contributed to an overall portfolio return.

 We hope you enjoy today's presentation. Now let's get started.

We begin our discussion with a high-level look at a collection of major asset classes.

As we can see from the illustration, US, developed international and emerging stocks were down during the third quarter. Reversing the positive trend from the prior quarter.

Returns for bonds were down for the quarter both domestically and internationally. But still up over the trailing 12-month period.

Next, I'll draw your attention to the upper right-hand portion of the graphic.

The US dollar was up 3.2% for the quarter, but is still down 5.3% over the last 12 months.

Now let's look a little deeper at what was driving the returns of stocks and bonds.

Global Equities

We'll start by taking a look at how global equities performed for the quarter. And will isolate the performance between US and developed international stocks.

The two charts show the performance of different investment styles between the US and international stocks.

The bright blue bars represent the performance of different investment styles, and the dark blue bars represent the total market performance for the region.

US returns are measured by the Russell indexes, and international market returns are measured with the MSCI World X US index series, 

which represents global developed market performance, excluding the US.

As we can see from the dark blue line on the chart on the left, The US market was down 3.3% in the third quarter compared to down 4% for developed international markets on the chart on the right.

Large-cap stocks and value stocks, on average, outperform the market in the US, with small value stocks leading the pack domestically and reversing the trend from last quarter.

Internationally, small-cap stocks and value stocks tended to outperform the market with international large-value stocks posting the only positive, albeit poultry performance for the quarter among global developed regions.

But no matter recent trends, it's important to remember that we shouldn't make longer-term projections based on short-term performance.

U.S. Equity Style Returns

Now we take a longer view to see how different investment styles have performed for standard periods ending September 30th 2023.

Looking at annualized returns in the US, we can see that markets have shown resilience, especially over the trailing one-year period, when faced with significant headwinds.

Such as ongoing fears of a global recession, uncertainties surrounding the future path of interest rates and fed policy, and growing dysfunctional on Capitol Hill.

Despite these potential issues, US markets returned 20.5% during the last 12 months, and either nearing or exceeding 10% per year during longer time horizons.

Large growth stocks had the best performance for the trailing one-year period, gaining 27.7%, which beat the US market by 7.2%.

We can also see that small and value stocks have generally been out of favor during these time periods, with the three-year period being a notable exception.

Consequently, we expect their portfolios that have a small value tilt, such as those that we typically design for clients, will have underperformed portfolios that are market cap-weighted or tilted to large growth stocks at these longer investment horizons.

Keep in mind that, however, very long-term evidence demonstrates that on average, small stocks outperform large stocks and value stocks outperform growth stocks.

But size and value factors can still go through extended periods of underperformance, like those shown on the screen. 

International Equity Style Returns

Turning to international markets. We see that large-cap value stocks have led the pack over the one-year period. While also outpacing the US market and all US equity styles.

At the longer time horizons, we see varying performance among different styles with value stocks, large-cap stocks, and growth stocks each posting leading performance over the trailing three, five, and ten-year periods respectively.

Related to the prior slides, we see that international markets have outperformed the US market by 2.6% during the last 12 months. But it underperformed the US market at all other time horizons with the three, five, and ten-year performance trailing by 3.9%, 6% and 7.4% respectively.

Given the higher US return over longer time horizons, we expect portfolios concentrated in US stocks to have outperformed a globally diversified portfolio.

However, as we'll see in the next slide, These relative performance numbers are not reason enough to abandon international stocks.

Relative Cost of Earnings Through Time

Thus far, we've discussed quarterly performance on a relative and absolute basis.

Now let's take a look at current stock market valuations and how they relate to future expectations of market performance. 

The charts on this slide show how expensive stocks are by measure of the price-to-earnings ratio, a very common metric used to value equities.

The higher the ratio is, the more expensive the asset class is overall.

Thought of another way, these values depict how expensive one dollar of earnings is. For example, as we can see in the chart on the top left, the average dollar earnings for the total US stock market cost roughly $21 dollars. Internationally, as we can see in the chart on the top right, earnings are cheaper at just under $14 dollars per dollar earnings on average.

The values represented here use historical fund and ETF data to establish the price ratios, and the average PE is reflected by the dotted line on the chart.

These averages start in the first quarter of 2004 for US measures and in the fourth quarter of 2006 for international stocks.

Noting the strong market performance during the last 12 months, we see both broad US and international markets are now trading close to or above their recent historical averages. We can also see that small-value stocks in global developed markets appear cheaper relative to their recent historical averages.

All else equal, we'd like to pay less for a dollar of earnings.

These valuation ratios aid in setting expectations about the future.

Low valuations today imply higher future returns and vice versa.

The recent strength of broader US market performance means that it's reasonable to expect lower returns than in the past when valuations were below their long-term historical averages.

The opposite is true for international markets and small-value stocks globally.

It's reasonable to expect higher returns than in the past when valuations were above their long-term local averages.

I'll emphasize that this is a long-term relationship and that short-term outcomes will likely be dominated by unexpected market forces.

Here we have the same analysis, but isolating US equities so we can see how valuations compare across different styles.

We're calling the annualized performance slides. We know that large growth has had an exceptional 10-year period. We can see that the growth in prices has see that the growth in earnings as the PE ratio has climbed to 32.1 to close the quarter, which is above its average since 2004.

Small value on the other hand, even with the rebound of value stocks relative to gross stocks during the last three years, still has a PE ratio of 9.3 and it remains under its average since 2004.

Although many investors may be interested in chasing the returns of large growth companies, We would point to these valuation charts as one reason to stay the course in a diversified portfolio tilted to small, relatively inexpensive companies.

U.S. Fixed Income & Rates

Next, we'll take a look at fixed income performance, the shape of the current yield curve, and how the market is currently pricing inflation.

U.S. Bond Performance

The charts on the screen show the average performance of different bond maturities and the segments of the fixed income market that we commonly track.

We typically prefer investing in bonds that are shorter maturity and higher quality compared to the broader market.

In the chart on the left side, We see that bonds of most maturity ranges had negative performance, but markets favored short to intermediate maturities relative to longer maturities. With the one to three-year segment posting modest gains.

The chart on the right shows the performance of different intermediate-maturity credit quality bonds.

We see again that all bonds in the credit qualities listed were down for the quarter with investors favoring treasury securities relative to other credit segments.

Next, we'll look at the treasury yield curve and what it means for returns going forward. 

U.S. Interest Rates

Here we plot the yield curve to show the current yield for treasury bond investments at different maturities.

The light blue line represents current rates. The dark blue line represents rates from the end of last year. And the gold line represents rates from one year ago.

Rates increased for all maturities during the quarter, particularly at the longer maturity segment on the curve, with the benchmark 10-year yield reaching 4.59%, a level not seen since October of 2007.

Looking forward, expect the returns for fixed income remain elevated to this time last year due to the Fed's rate hike program.

For long-term fixed income investors, this is likely to be a net positive as new money and maturing bonds are reinvested into higher-yielding bonds.

The yield curve remains inverted as it was at the end of last quarter. When this happens, particularly between the two-year and ten-year points on the curve, It is widely regarded as one of the precursors, but not as a guarantee to an impending recession.

U.S. Projected Inflation

Finally, we plot markets forecast of inflation by taking the difference in yields between US treasury bonds and tips at different maturity levels.

Like the last chart, the bright blue line represents current inflation expectations.

 The dark blue line represents inflation expectations from the end of last year. And the gold line represents inflation expectations from one year ago.

Current market estimates for future inflation have been little change compared to the beginning of the year. And this time last year. As the Federal Reserve's aggressive rate hike campaign has met resistance from sticky inflation readings. Driven by growth in the economy service sector, which tends to be less sensitive to interest rate movements.

Inflation expectations rose slightly for the most part across curve this quarter, with the exception of the five and seven-year horizons.

As these expectations continue to change, It's important to remember that these levels of inflation are baked into prices today.

The markets are pricing an average inflation rate of only 2.2% per year for the next five years, and the market collectively expects inflation to slightly outpace the Fed's 2% target over the next 30 years.

Not only are these expectations baked into bond prices, but they're also baked into equity prices.

Making a bet on higher inflation would mean that we expect inflation to exceed the current forecast.

Contribution to Return

Next, let's take a look at how some major asset classes contributed to a 60/40 index mix this quarter and how that index mix behaved during recent history.

On this slide, we look at the absolute impact of different asset class returns on the quarterly return of a sample 60% stock, 40% bond index mix.

With stock and bond markets moving mostly downward this quarter, we can see that all stock asset classes contributed to the overall decrease of the index mix.

US large-cap stocks were the largest detractor for the quarter, while global short-term bonds were the only asset class to contribute positively to the overall return. 

Diversifying stocks across geographies and investment styles as well as allocating to bonds, help avoid undue portfolio concentration risk, and help limit losses this quarter.

This resulted in the 60/40 index mix achieving a return of negative 1.9% versus the US total market return of negative 3.3%.

The portfolio controlled market risk while limiting losses.

The Effects of Diversification

Here we see a collection of major asset class calendar year returns displayed on a quilt chart.

Looking at year-to-date returns in the rightmost column, we see that most asset classes posted positive performance with the S&P 500, popular headline index primarily tracking US large growth company performance, gaining the most value at 13.1%. 

A diversified index mix, such as the 60% stock, 40% bond index mix shown in the white tile, tends to stay away from the extreme returns, both positive and negative on a yearly basis and over time, while also damping the volatility of returns.

This is an example of the potential benefits of a well-diversified portfolio.

It also helps us as investors to stay in our seats through any given quarter of market turbulence and not take away our ability to prosper from the many quarters to come.


And with that, we've reached the conclusion of today's presentation. Thank you for joining us, and we'll see you next quarter.

Beacon Hill Private Wealth is an independent, fee-only, fiduciary investment advisor providing evidence-based wealth planning solutions that simplify our clients' financial lives. Founder Tom Geoghegan, CFP®, CIMA®, CPWA®, RMA® is also a member of the National Association of Personal Financial Advisors (NAPFA).      

This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice.  The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Please consult legal or tax professionals for specific information regarding your individual situation. 

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