After stock and bond prices rose unexpectedly strong in the first half of the year, quite a few storm clouds gathered in the third quarter. The months of August and September presented an echo of the financial market weakness of 2022, i. e., interest rates rising especially at the long end, falling prices of technology and growth stocks paired with stability in ‚value stocks‘, weaknesses in China and gains in India.
However, the recorded losses were not nearly as high as last year. The broad-based equity indices of the MSCI and FTSE Russel families continue to show double-digit gains for 2023. But indices tracking the shares of small and medium-sized companies have roughly halved their returns since mid-year.
The weakness of bonds with medium to long-term maturities is most unpleasant. Almost all the gains of the first half of the year have melted away in Q3. Bonds with a maturity of more than 20 years show high single-digit losses. However, bonds with short maturities were able to maintain or even increase their gains, as they are not suffering from price adjustments that longer-dated bonds incurred because of interest rate rises on the long end of the yield curve. Generally, the longer the maturity of a bond, the more it reacts negatively to rising central bank and capital market rates.
Whereas long-dated bonds were recording huge capital gains during the years of falling interest rates, following the Global Financial Crisis and Covid, they are now suffering the most from rising interest rates.
The reason for the weakness in bond markets in August and September was the fact that both the ECB and the US Federal Reserve made it very clear that whilst they believe they are close to the end of their interest rate increases, they do not see themselves
in a position to lower reference rates significantly in 2024. This contrasts with the assumption of many capital market participants who expected several interest rate cuts for next year. The new central bank message is ‚higher for longer‘, i. e., a tendency towards higher interest rates also in the medium and not just the short term. Financial markets did not expect this message and took it as an opportunity to sell bonds with medium to longer maturities.
2022 has already shown us that quality growth and technology stocks suffer significantly from rising long-term rates. This explains the recent correction in the Nasdaq 100 index and quality growth stocks in the third quarter. At the same time, ‚value strategies‘ have fared better, as they generally display lower valuation levels and thus compare more favourably to bond valuations. Consequently, the value-tilted multi-factor indices of Dimensional Fund Advisors have performed well in this environment.
Another factor that caused global financial markets to reverse their positive trend was the renewed strength of the US dollar. From the end of June to the end of September, the US currency gained about 5-7 % against major currencies. A rising dollar tends to lead to falling prices in financial markets, as it has the same effect as an interest rate hike on capital market participants who borrow in US dollars.
On top of that, the oil price rose significantly in September, which has an inflationary effect and causes volatility.
Finally, it should be noted that August and September are generally accompanied by strong volatility and asset price drawdowns, probably because of a dearth of news combined with the fact that many traders are on vacation. Fortunately, we have now entered the 4th quarter, which usually brings about a more positive market environment.
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