Q3’23 – Hold on a minute here…

Q3 2023 was the first quarterly decline for the US stock market (the S&P 500) for the year, down roughly 3.5%. Bonds took their share of losses as well. Within the Treasury market, longer duration bonds have taken it on the chin — the iShares 20+ Year Treasury Bond ETF (TLT) returned -7.9% in September, and is down another 7% in October. Moreover, with two months to go in 2023, Treasurys are on track for their third consecutive year of losses. That has never occurred in the entire history of the United States. Ouch.

While the first half of the year was primarily driven by investor optimism in the growth prospects of large technology stocks due to the tailwinds of increased efficiencies enabled by AI, there has been a growing amount of skepticism of the economy and markets. The growing chasm between the "bulls" and the "bears" now practically resembles a political landscape, where both sides harbor anger and resentment, struggling to find common ground. This discord is unsurprising, considering the abundance of contradictory data coming from leading economic indicators and bond market volatility.

However, the best entry points have been when market skepticism is the highest ala March 2023 after the collapse of SVB and Signature Bank, or October 2022. The sharp selling off in September to important technical support levels aligned with momentum and breadth reaching oversold levels, indicating sentiment had grown extremely bearish (fear and greed index hit October 2022 levels). Often, this translates into attractive opportunities for equities, which can explain the early October rally. Additionally, September is infamous for being a tough month seasonally, as it’s the only month over the last 100 years where returns are actually negative. Inversely, Q4 is known for its strength, especially recently. Since 2019, the S&P 500 has returned 9.4% in Q4 on average.

The beginning of Q4 2023 has been defined by the rapid rise in long-duration rates (10 – 30 year instruments) which has caused the equity markets to become unsettled although they have remained fairly resilient. It will likely take some time to digest these rate increases.

Many have asked why interest rates are spiking. It’s difficult to assign exact attribution percentages, but it’s a combination of:

1) Concerns that the increases in government spending will continue to accelerate and begin to spiral out of control (necessitating issuing more and more debt at higher and higher rates)

2) Political instability in Europe and the Middle East

3) Higher inflation for longer concerns as headline CPI in September accelerated on the back of higher energy prices (0.6% month-over-month, 3.7% year-over-year), while core inflation grew at a more modest rate (0.3% m/m, 4.3% y/y), but still too high

4) Economic growth remaining resilient

Q4’23 Earnings Preview – and Reasons for Growing Optimism

While there are definitely risks keeping us cautious about the near-term, there are also reasons to remain optimistic. For Q3 2023, the S&P 500 is estimated to post a year-over-year earnings decline of -0.3%, however, analyst earnings estimates are typically beat by ~3% on average, which suggests that earnings will actually increase this quarter, which would be the first quarter in a year that earnings growth inflects into the green. More important though, is the outlook for next quarter, Q4 2023, and analysts are projecting earnings growth to continue to inflect upwards; forecasting EPS growth of 7.8% and revenue growth of 3.9%. In fact, Wall Street equity research analysts are projecting EPS growth from here on out into 2024, suggesting that earnings have troughed (see chart below).

Another significant positive is the continued strength of home equity, a cornerstone of wealth for many Americans, accounting for approximately one-fourth of total household net worth in the US. This strength is particularly noteworthy in light of mortgage rates increasing significantly, portraying the supply/demand imbalance due to the ongoing housing supply shortage in the country, a situation compounded by the fact that roughly three-quarters of American homeowners have secured interest rates below 5%. As a result, they are hesitant to trade these favorable rates for today's prevailing 30-year fixed rate of 8%, contributing to the persistently low housing supply. Thus, this is likely to remain a highly resilient asset class. It’s difficult for the US consumer sentiment to get too sour when their home is still up ~40% in the last 4 years, the largest 4-year gain on record (see below graph of the median sales price of a home in the US dating back to 1963, and note the massive spike in 2020).

Lastly, the labor market has remained resilient as well. US average hourly earnings are up 19.25% since the beginning of 2020, which has actually outpaced inflation, as measured by the US CPI (Consumer Price Index). Even though people hate paying higher prices, when you consider the wage growth we’ve experienced, and the massive amount of inflation in home equity and the stock market since the beginning of 2020, the consequent rise in prices for goods and services isn’t as damaging.

Portfolio Strategy

While we’re far from being in a Goldilocks scenario and the aforementioned risks have merit, US consumers are still in good (arguably great) shape. Many people have been psychologically preparing for a recession for over a year now, and have a high margin of safety in their financial position, also evidenced by record cash levels and over $5 trillion in money market accounts that are yielding attractive rates. We continue to believe that this is a market to remain invested in with a tilt towards the overlooked, inexpensive sectors of the market that are still performing strongly on a fundamental basis and are likely experiencing troughing earnings, as well as short-duration fixed income. Remember, not all stocks bottom at the same time; some are priced for more distress than others, and vice versa. The markets are also in a unique position where downside risk is limited as the Fed is in a position of strength given they have the ability to lower interest rates from their current restrictive levels above 5%. This maneuver would ease the tight financial conditions, preventing the economy from entering a painful recession that many of us are fearful of given our nature to exhibit recency bias.

We are grateful for the trust that you have placed in us, and we look forward to continuing to serve as your partner in achieving your financial goals. If you have any questions or concerns, please do not hesitate to contact us.

Information presented reflects the personal opinions, viewpoints and analyses of the employees of Mirador Capital Partners, LP, an SEC-registered Investment Adviser. The views reflected in the commentary are subject to change at any time without notice. Nothing herein constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Mirador Capital Partners, LP manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. Visit us at miradorcp.com for more information.

Q3 Letter - 2023