The third quarter was defined by a sharp move higher in interest rates. The 10-year U.S. Treasury yield climbed above 5.3% in September, reaching levels not seen since 2007. Unlike periods when higher rates have been driven primarily by Federal Reserve policy, several crosscurrents are contributing to today's environment: resilient economic activity, renewed inflation pressures, and concerns surrounding the amount of debt being issued by the U.S. government.

Economic data has remained surprisingly resilient. The S&P Global U.S. Manufacturing PMI reached 57.0 in September, its highest reading since 2015 outside of the COVID reopening, signaling continued strength in the manufacturing economy. The labor market has been less consistent, but August payrolls rebounded by 162,000 after a weak July. At the same time, consumers continue to spend. August retail sales increased 1.2% from the prior month and 6.0% from a year earlier.

Inflation has also remained stubborn but is cooling. The latest estimate showed the PCE price index rising at a 3.0% annualized rate during the third quarter versus 3.3% estimates. Oil has been a leading source of inflation pressure during the quarter. By late September, West Texas Intermediate crude was trading near $98 per barrel, substantially above the $66 level this time last year.

JFG Outlook

Many of us remember the challenges we went through during the 2008-2009 financial crisis. That moment in history illustrates why owning bonds can be critical to the diversification of a portfolio designed to generate income in retirement. From October 9, 2007 through March 9, 2009, the S&P 500 declined approximately 56%. An investor retiring immediately before that decline with an all-stock portfolio would have been forced to fund living expenses by selling stocks as their values fell, permanently realizing some of those losses. High-quality bonds behaved very differently during that period, returning over 8%. ⁽¹⁾ That is the purpose of diversification: not for every investment to perform well at the same time, but for each part of the allocation to do its job when it is needed most. With high-quality bond yields around 5%, investors can now earn levels of income that were largely unavailable for much of the past two decades. We do not expect bonds to outperform stocks over the long run, but they do not need to outperform stocks to fulfill their role in a diversified portfolio.

The relative attractiveness of bonds is particularly relevant because equity valuations remain elevated. The Shiller P/E ratio, which compares today's stock prices with the inflation-adjusted average earnings of the previous 10 years, recently reached approximately 41. By comparison, it peaked around 38.6 in 2021 and approached 44 during the technology bubble in 2000. Unlike a traditional P/E ratio, which generally relies on the previous 12 months of earnings, the Shiller P/E attempts to smooth the earnings cycle and provide a longer-term perspective on how much investors are paying for corporate profits. A high Shiller P/E does not tell us when stocks will decline, nor does it mean investors should abandon equities. It does, however, illustrate that investors are currently paying historically high prices for each dollar of long-term earnings. 

In summary, we continue to believe stocks are essential for long-term portfolio growth, while bonds serve a different purpose: generating income, preserving liquidity, and providing stability during periods of equity market stress. Rather than attempting to predict which asset class will perform best over the next quarter, we remain focused on matching each client's portfolio with the timing and purpose of their future financial needs.

Thank you for your continued trust in Juno Financial Group.

Sources

1. FactSet