The unprecedented dichotomy in stock performance continued in the third quarter. As you can see in the chart to the left, over the past 20 years, the S&P 500 Index (weighted by the capitalization, or total value of each company) has performed relatively similarly to the S&P 500 Equal-Weight Index (all companies weighted equally, regardless of size). There is less than half a percent difference in the annual average of the two. This year, however, the spread has been startling. Year-to-date, the cap-weighted index is up 13.1%, but because nearly all the strong performance is concentrated in the handful of largest tech companies, the S&P 500 Equal Weight Index is up only 1.7%. Both fell in the third quarter. Bonds also fell in the third quarter, dropping -3.2% on average. The Bloomberg Aggregate Bond Index is now negative at -1.2% year-to-date.
The outperformance of just a narrow group of stocks is expected to reverse as monetary and fiscal policy tighten. We start the fourth quarter with a high Federal Funds Rate that may be raised again at the November or December meeting. Longer term rates have been moving higher as well and have driven the 30-year mortgage rate to 7.7%. Mortgage applications are now at their lowest level since 1995 as a result. Interest rates are not the only drag on the economy at this point. September brought the return of student loan invoices, oil production cutbacks by Saudi Arabia and OPEC partners, an IRS pullback in tax credits to small businesses, workforce strikes across several industries and the end of COVID-era subsidies to childcare facilities. The combined impact of these factors will provide the Federal Reserve with a solid assist in their quest to slow the economy and restrain inflation.
A slowing economy rarely inspires optimism, but if the Federal Reserve believes this slowdown is sufficient to declare an end to their interest rate increases for the foreseeable future, the stock market could “look through” the weak period to more favorable conditions in 2024. It would also be helpful if Congress could agree on and pass the budget bills needed to avoid a government shutdown ahead of the holiday season. Their current deadline is November 17th, and as everyone is aware, they have a lot to accomplish between now and then. Suffice to say, the less Congress is in the headlines, the better for markets.
The next year will bring increased investment spending and tax incentives previously authorized by the 2021 Bipartisan Infrastructure Deal, the IRA Clean Energy Bill, and the CHIPS Act. An initial Federal Reserve rate cut could also be in the cards if inflation subsides sufficiently. And it is an election year; we never underestimate the lengths politicians of all stripes will go to ensure an upbeat economy as voters head to the polls. So, while we are not particularly bullish on the immediate future, we see plenty of reason to stay invested for brighter days not too far ahead.