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September 2023 highlights


This is Mark Peterson with the September 2023 Student of Market Update. We'll hit handful of topics this month. we'll talk about bonds, and the Fed certainly dominating a lot of conversations out there. Then we've got handful of things on stocks, specifically some seasonal issues. Also the election next year, a concern for many. And then, some longer term investing ideas, some rules-of-thumbs, some economic cycle tidbits that we thought were very timely.

(00:32) Slide 3: Inflation adjusted (real yield) for bonds

So let's jump right and talk about the inflation-adjusted yields for bonds. Known as real yields. This has been popping up in conversations lately, just the fact that when you inflation-adjust the yields for bonds today -- and this is based on inflation expectations in the future -- you've got about 1.9 percent at the end of August. So, almost two percent yield after that inflation expectation is subtracted out. You can see that's the highest level we've seen since the Global Financial Crisis. Certainly, you can see how low and negative that it got during the global pandemic, even post Global Financial Crisis, as interest rates were super low. You took out that inflation, you're actually at a negative number. And you can see on the right side that we put bond in stock returns on the right at various real-yield levels. So, one and half percent was the threshold -- that's about average for the period on the left by the way. So that's why we chose one and half percent. You can see bond returns much better when you're getting that nice real yield of one and half percent or more. We're clearly there today, which bodes well for bonds. Really anywhere on the yield curve, but core bonds in particular. And you can see as that real yield level drops and gets less than zero, your bond return going forward suffers pretty drastically based on that. Then on the far right side, of those fascinating to see on the stock side it was actually inverse based on those real yield levels. So the higher the real yield, the less the stock returns; bonds, all of a sudden, look more attractive and start to gathering perhaps some dollars at those real yield levels. Versus, when real yields are less than zero: Look at stock returns, they're the only game in town and they return over 16 and half percent when those real yields are less than zero. so thought that was an interesting story certainly something to keep an eye on as we move forward interest rates have backed up here making those real yields look really attractive.

(02:45) Slide 4: Real yield impact on stock and bond correlation

A little bit more detail on real yields. You can see the calculation on the left -- pretty straightforward. Just taking that 10-year treasury yield at the end of August minus the inflation expectations get you to that 1.9 percent number. I had a question from folks across the country, advisors looking at what that meant for correlations for stocks and bonds at various real yield levels. I thought this was interesting if you look at it, and probably no surprise here, when you get a more attractive real yield, the correlation for stocks and bonds really starts to kick in; meaning, that they tend to be negative correlated. They don't move together, they tend to move more separately. Whereas, if you get a really low to negative real yield on bonds, that's when they're correlation kicks up. And that's obviously what we saw last year is the correlation for stocks and bonds kicked up they were both negative for the calendar year that was certainly painful for portfolios. And really set up by really low-to-negative real yields on bonds going into last year. So I think something to consider going forward; certainly another feather in the cap for bonds going forward with real yields high, not only bond returns, look more attractive. Historically, that tends to bode well for better correlations as well.

(04:14) Slide 5: What is the market expecting for the Fed Funds interest rate going forward?

Certainly the Federal Reserve getting a lot of attention this year. What are they going forward? Are they going to raise maybe one more time in November? It seems to be where the some of the market's thoughts are. we wanted to put in some of the pricing on the left side just what the market expects. And again, this is that the end of August, so this certainly moves fast and quick in the marketplace. The numbers on the left will change. But you can see the story is that the end of August, they weren't pricing in anymore hikes. Although it was close in November of this year for another quarter point hike. And then, they have a decrease in interest rates or a cut in the middle part of next year. So really, starting in May, the June meeting, then you can see really kicking in towards the back half of the year, where they bring rates down about a full percentage point is what the market was pricing is. So I thought that was interesting and certainly something to keep an eye on. Again, it does fluctuate quite quickly. On the right side, we just highlighted in a reminder what the stocks and bonds have done in different interest rate. Fed rate hike cycles, right, certainly when they're raising interest rates, doesn't bode well, especially for bonds. When they're paused, it actually looks pretty good for both stocks and bonds. And when they're cutting interest rates, it looks really good for bonds. Not so much, a little bit more of a mixed bag for stocks, especially the last couple interest rate cutting cycles during the pandemic. Certainly, back to the Global Financial Crisis, and even the tech bubble, you had some cutting cycles that accompanied pretty deep and severe recessions. So stocks certainly suffered. But I thought that was a good reminder. If we move into a pause or even a cutting cycle, especially on the fixed income and bond side, that should bow very, very positive for returns going forward.

(06:20) Slide 6: The gap between short-term and long-term interest rates is shrinking (peak yield curve return)

Last thing on bonds and fixed income, just wanted to highlight the fact that the yield curve inversion -- meaning, the fact that short-term interest rates are higher than longer term rates -- has backed off quite a bit. So, we're off peak yield curve inversion, if you want to call it that. We have that back at the end of May we're short-term rates. And this is measured by the 3-month treasury bill was almost two percent higher than a trend 10-year treasury bill. It seems almost counter-intuitive for most investors: Why would you ever invest in a longer maturity bond in a longer maturity bond if you can get a higher income level in a shorter term bond with much more flexibility, much less interest rate risk? But historically, this is a good time to buy bonds. And, we just wanted to see whenever you get peek yield curve inversion, what happens to bond returns going forward? You can see that on the right side, no surprise, bond returns look great following peak returns. Almost eight percent returns for core bonds following peak yield curve inversions. And of course, yield curve inversion, the peak inversion is closer historically to that recession. So it's not just the fact that bonds are predicting a recession. Once you hit peak inversion, that happens prior to the actual recession as well, at least in the last four instances that we highlight on this slide. So I thought that was interesting, something again to keep an eye on, this peak yield curve inversion as this comes down. A good sign for bonds, and probably means we're a little bit closer to a possible recession.

(08:03) Slide 7: September is historically the worst month for stocks

Switching gears to stocks on slide seven, we are moving into the toughest month historically for stock returns. You can see that on the left, September sticks out like a sore thumb. The only month that is negative. you see some others here, February is pretty close to low to zero; May is a little bit of a mixed bag. But by far, September is the toughest. I think a lot of folks think October is actually the worst but it actually looks pretty good and look at the last couple months of the year pretty strong. I wanted to highlight the fact on the right too, just the percentage of months historically that are positive and negative. And this goes back to 1926 so this is about 98 years of history here. And you can see that some of the months, that are less impressive, like May where you only average on the left side about half percent return, you still are overwhelmingly positive almost two thirds of the time in May or you're positive. Then you drift down to September number, look at September, not only are negative but year by far the most likely to have a negative monthly period. It's about 50/50. It's slightly above 50 percent positive, but that is by far the worst month. Then he can see again, February back towards the top. Only 55 percent positive clearly the second worst month on the board. But I thought it was interesting in general, just looking at all those months how dramatically positive. You've got almost a 60-40 chance of being positive when you aggregate this up. I think that's certainly speaks to the long longer term benefit for stocks, how amazingly resilient and consistent they've been over time. The fact that the worst month in history is still a 50/50 proposition, pretty compelling for stocks long term.

(09:55) Slide 8: Upcoming election year and historical stock returns

Looking at the election, certainly questions coming about entering an election year. What does that mean for stock returns historically? Again, going back to 1926, you can see election years actually are pretty darn good, 11.7 percent. The non-election years like this last year and this year certainly holding true as a non-election year holding its end of the bargain, on average of 14.6 percent. It's those mid-term election years that tend to be the stinker, well below average for stock returns at 7.4 percent. So wanted to arm folks with this I know this is coming up in conversations as primaries heat up. But again, election years tend to be pretty darn good -- specifically within those years, just wanted to see the fourth quarter before an election year. Normally we don't like to slice it up this thin, but just thought it would be interesting just to look at fourth quarters in general, and in non-election years, which is prior to the election and the yellow on the right hand chart there, you can see you average five percent in the fourth quarter leading up to an election year which is pretty positive in general. But fourth quarters generally tend to be good overall, but then prior to an election year tends to be pretty darn good. So I thought that was interesting to highlight.

(11:16) Slide 9: Economic cycles and expected asset class performance

Finishing up now with some economic cycles and asset class performance -- this is something we ran a couple years ago with some folks honor economic side at our BlackRock Investment Institute. Just looking at the various economic cycles and what does well in some of these cycles, and how some of these aspect-class performance expectations can rotate through. You can see we're probably somewhere, we've been tug of warring between the expansion and the slowdown, so right in the middle of the chart you can see some of the things that have done well this year like quality certainly doing well, as we tug a war between a better-expected economy so far this year. But certainly slowing material heading into next year. Probably the right side of this chart is going to really start to come into play. again it leads you down to that core fixed income road, really anywhere on the fixed income yield curve backs that up. If we get into a more material slow down, that's what does well. High quality credit, certainly government bonds, intermediate term bonds tend to be the winner there. Again quality, minimum volatility I think all make good complements to portfolios at this point of the cycle. Again, we've been tugging that tug of war between a better than expected economy, but still slowing. We can see the slowdown in growth coming. It's just a matter of how deep, long-lasting it'll be. At this point, we don't think it'll be too dramatic, even if it does tick into recession territory in 2024. But again, hopefully this chart helps you give you a little bit of road map of what to expect. But, of course, one of the challenges always with this chart is figuring out where you're at in that economic cycle. It's always tough to pinpoint that with any accuracy.

(13:13) Slide 10: Understanding the investment math

Last thing I want to highlight, something I've wanted to do for a while, just look at some of the math behind investment. Returns on the left-hand side, looking at how long it takes you to double or triple your money. So the rule of 72 and the rule of 115. Not exact, but a great guide for folks just take whatever your average return is, and divide that into 72. That gives you how many years it takes you to double your money. So if you have 12 percent return, it only takes you six years to double your money. And the rule of 115 how long it takes should a triple your money. If you have five percent, it takes you 23 years to triple your money. But just thought that was something nice to share with investors, give them the upside and just the difference that bigger positive returns can have on your investment outcome at the end of the day I think it's pretty powerful. Looking at you can look at cash rates right, cash, it's like attractive. But if we can do a little bit better in a rediversified portfolio, look at how much quicker at eight and ten percent, you're doubling and tripling your money. I think that's a nice story to tell. And then on the far right is the other end of the spectrum, the fact that if you lose money and you have a bigger negative number, you need to be up more to get back to just break even, that minus 50 up 100 percent scenario. It doesn't matter whether you start with a dollar or $1 million dollars, that's always the case. I always like to look at one step to the right: Minus 50, up 100. Look at the minus 60, now all of a sudden you have to be up 100 and 50 percent to break even. That's obviously why risk management, downside risk is so important. You don't want repair your portfolio by getting too far to the right on the chart on the right there. That's really how you impair your investment outcome over time. you need to balance that risk return, and stay of the left side, that chart on the right.


So, that does it for our September Student of the Market update. As always, if you have questions, comments or suggestions for content, you can put that through our website. If you just Google, 'BlackRock Student of the Market', a little pop up, and there is an area for comments and questions. Some of the best ideas come from advisors across the country so we always appreciate that. So with that, we'll see you next month on BlackRock’s Student of the Market update.

Inflation adjusted (real yield) for bonds

Historically, periods of 1.5%+ real yields has been the strongest period for total return of bonds, which have seen a 6.4% average return during the following 12 months.

Real yield impact on stock and bond correlation

With lower real yields, bonds had seen their diversifying role diminished. However, periods of real yields has tended to mean negative correlations to stocks, historically.

Upcoming election year and historical stock returns

Non-election years such as 2023 have tended to see stocks perform well, with an average annual return of 14.6% since 1926.

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