Q3 2023 Market Update: Climate Change

No, we’re not referring to the existential threat to humanity. We are, however, referring to the investment climate.

The investment climate has had roughly 10-year cycles over many decades. The cycles are usually caused initially by a “loose” monetary policy by the Federal Reserve (the Fed), where money in the financial system is ample and financing is easy to obtain. This has ultimately led to reckless borrowing and speculation in the stock market. The Fed then intervenes by raising interest rates and constraining the amount of money in the system. That, in turn, has led to an economic recession and a bear stock market to culminate each cycle.

Each bear market has cleared out excesses and paved the way for a new cycle of growth and market appreciation, as the Fed changed to a policy of cutting interest rates and injecting money into the system to stimulate a recovery.

Cycles Over the Past 30 Years

There were three bull markets and investment bubbles in different asset classes over this period: the “dotcom” technology stock mania of the 1990s, the housing bubble in the 2000s, and the bull market in the broad stock market from 2009 to 2019.

At the beginning of the most recent cycle, conditions for investing in the stock market could hardly have been more favorable. In response to the Global Financial Crisis and the Great Recession in 2008-2009, the Fed cut short-term interest rates to 0.15%, and the government spent more than $1 trillion to rescue key financial firms and the auto industry. Though the stock market and the economy had begun to recover, the Fed kept short-term rates near 0% for almost seven years. This absence of adequate yields on savings and fixed-income investments led to a surge of stock purchases. The mantra of the era was “TINA,” or “There is no alternative” to investing in stocks.

Then came COVID, which in the spring of 2020 led to the greatest economic shock since the Great Depression. The government responded with a record stimulus of almost $9 trillion (40% of the size of the U.S. economy), flooding money into the hands of consumers and businesses, and the Fed cut interest rates back to near 0%.

That led to spending and speculative excesses once again (and a spike in price inflation), so in March 2022, the Fed began raising interest rates—in the most aggressive way in 40 years. Stocks fell sharply through most of 2022, then rebounded this year (typical after the initial decline in a bear market). So here we are.

The Current Climate

It is impossible to predict even short-term economic and market outcomes, much less the precise timing of a secular change in the investment climate. It is, however, an investment manager’s primary job to use market historical experience, along with an appreciation of the inexorable pull of “reversion to the mean,” to assess the return prospects for various asset classes, versus the risks they present.

Current conditions could hardly be more different than at the start of the last cycle. Stock market valuations then were among the cheapest on record; today, they are among the most expensive. With such high starting valuations, it is simply historical math—not prognosticating—that returns from the main U.S. stock indexes will be well below average.

Economic and profit fundamentals also do not help the case for stocks. At the start of the last cycle, both were improving. Now, regardless of estimated strong Q3 GDP growth, the economy and profits are weakening (the Conference Board’s Index of Leading Economic Indicators has fallen for a record 17 straight months).

But bonds are appealing. Government bonds now yield 4.5% to 5.5%, and some short-term social impact bonds are seeing 6% yields. The dividend yield on stocks is only 1.5%.

The current investment climate warrants a maximum weighting in bonds and cash and a minimum weighting in stocks.

Current Investment Strategy

Though the S&P 500 is historically very unattractive, that is not true for all stocks. The stocks of many quality companies have already fallen by 20% to 60% from their peaks and are now deeply undervalued versus their historical norms (some have dividend yields of 6-10%).

And don’t forget a hefty dose of cash, because buying opportunities inevitably arise, sometimes suddenly.

We might be a bit early in buying deeply undervalued stocks that we think have already completed the bulk of their bear market. Our recent market performance has been disappointing, especially when compared to the S&P 500 (the main proxy for “the market”). But almost half of the S&P’s gain this year has come from the seven largest technology-oriented companies, dubbed “The Magnificent Seven”: (Apple +37%, Microsoft +37%, Amazon +54%, Google (Alphabet) +55%, Facebook (Meta) +165%, Tesla +115%, and NVIDIA +211%). Meanwhile, the average return for the 500 stocks in the index is 0%.

As for bonds, the sharp rise in yields (and drop in values) over the last several months has surprised us. But here again, we think bonds offer outstanding value, with inflation and the economy both sliding.


Investors in the stock market—at least in the S&P 500 and in the Magnificent Seven stocks—are not receiving adequate compensation in prospective returns, given the historical high current valuations, to compensate for the above-average risk of substantial price declines. We think, however, that there are exceptions, particularly stocks in the telecom, health care, and health care REIT sectors. Those, combined with large holdings of high-quality bonds and money market funds, offer an attractive combination of high current income and the conservation of principal.