Published September 15, 2023
With our focus on the Nasdaq 100 (QQQ), we do not actively invest in bonds in our models. However, we know that many of our subscribers do. Below we offer the latest output from Delta Research. We hope you find it of interest.
“The iShares Core US Aggregate Bond ETF (AGG) representing investment grade, U.S. corporate debt was down -1.77% in 2021 and -13.02% in 2022. 2022 was by far its worst performance year ever. Never before has the AGG suffered from two sequential down years. The rolling 5, 3 and 1-year average annual returns of the AGG are 0.39%, -4.69% and -0.36%, respectively. An investor might expect bonds to bounce back after such negative performance. The index is up only 0.9% year-to-date, a significant disappointment.
The weak performance year-to-date is caused by the same driver that led to historically negative bond returns in 2021 and 2022. The Federal Reserve raised rates at an unprecedented pace to manage unprecedented inflation volatility. Bond values are inversely correlated with interest rates.
There is a reasonable probability that the Federal Reserve will not raise rates again in this cycle. This week on Wednesday when the total CPI was reported to be up 3.7% in August versus 3.2% in July, the 10-year treasury rate declined from a high of 4.34% to 4.24%. The probability of a Fed November rate hike fell from 44.2% before the CPI report to 39.1% just after. By June of next year, the market is pricing in a rate cut.
Although the CPI increased somewhat from the prior month, about half of the increase was from higher gasoline prices. At the core level, inflation continues to show signs of subsiding.
Three-month treasury bonds offer roughly 5.4% annual interest. Depending on the bond type and duration, it is possible to find bond funds with yields ranging from 5-9%. The combination of the Federal Reserve nearing the end of the rate hiking cycle and the high bond yields make owning bonds attractive on both a relative and absolute basis.
The S&P 500 is currently trading at a forward P/E multiple of 18.6x. Core CPI was just reported at 4.4% for August. The Rule of 20 says when inflation plus the market P/E multiple equals 20, the market is fairly valued. Currently, market P/E plus inflation is 23x. With stocks above their average valuation levels and with interest rates near 15-year highs, equity future returns may be subdued in the intermediate term. Bonds today offer relatively high yields and hopefully more price stability than equities.”
Market Update
Stock indexes continue to show volatility through the seasonally treacherous month of September. Monday brought +0.7% higher prices with Tesla popping +10% on an upgrade from Morgan Stanley. A -13% drop in shares of software company Oracle took the market lower Tuesday with the S&P 500 giving back -0.6%. Wednesday’s consumer price report came in as expected leaving markets little changed. Core inflation, less the volatile food and energy pieces, continues to trend lower while rising oil prices pushed up the overall inflation reading after a precipitous drop the prior month. Higher consumer spending numbers pushed markets +0.8% higher Thursday. The successful IPO of chip designer ARM Holdings brought some enthusiasm to tech shares. Climbing oil prices and a tick higher in interest rates combined with monthly and quarterly options expirations day to unnerve investors Friday. The S&P 500 gave up -1.2%.
Stocks could not pick a direction this week spending their third week trading tightly. The S&P 500 dipped -0.15% while the Nasdaq 100 (QQQ) slipped -0.52%. Smallcap stocks have fallen six of the past seven weeks. This week’s move was only -0.19% though.
Warm wishes and until next week.