The Month At-A-Glance
- The S&P 500 finished 1.6% lower during the month—its first negative month since February.
- A stronger US dollar took a bite out of foreign equity returns, with MSCI EAFE falling 3.8% and MSCI EM dropping 6.2%.
- To start the month, Fitch Ratings downgraded US long-term debt from AAA to AA+.
- Interest rates drifted higher amid growing “higher for longer” rhetoric—resulting in losses for core bonds.
The market started out the month on rocky footing—with the S&P 500 falling close to 5% over the first couple of weeks. Markets recouped some of those losses over the back half of August. The S&P 500 remains up 18.7% year-to-date.
Growth stocks widened their lead over value stocks last month. The Russell 1000 Growth Index fell 0.9% compared to a drop of 2.7% for its value counterpart. Last year was difficult for growth investors; however, this year has been just the opposite. The Russell 1000 Growth Index has opened up a 26.3% gap over the Russell 1000 Value Index so far in 2023!
Equity markets overseas underperformed US markets. A strong dollar (up 1.7% in August) was a headwind for foreign stocks. Developed international stocks dropped 3.8%, while emerging-market stocks underperformed with a drop of 6.2%. Chinese stocks fell 9% and were a material drag on the broader emerging-market index. Concerns about a slowing Chinese economy and a property sector that continues to struggle resulted in poor returns. China’s leadership has announced some targeted stimulus, such as rate cuts, lower mortgage rates, and lower down payment requirements. Despite this, confidence in China remains depressed.
Interest rates were volatile in August and ended the month higher. Fitch Ratings’ downgrade of US government debt, as well as a growing belief in the “rates higher for longer” narrative, pushed 10-year Treasury rates from 3.97% to 4.34% before retreating to 4.09% at month end. The 10-year Treasury has eclipsed yield levels not seen since before the Great Financial Crisis. Higher rates resulted in a loss for the Bloomberg US Aggregate Bond Index (down 0.6% in August).
The month started out with a ratings downgrade of US debt by Fitch Ratings. The ratings agency downgraded the US long-term rating from AAA to AA+. Fitch supported its decision by saying it “reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance.” Standard & Poor’s made a similar decision back in 2011 to downgrade the US credit rating following another fight over the debt-ceiling. Much like in 2011, Fitch warned that this year’s debt-ceiling crisis could result in a downgrade.
Government debts did explode higher in the wake of the pandemic (see chart below). Debt as a percentage of GDP has decreased in the last couple of years thanks to strong nominal growth (i.e., a larger denominator). Prior to the pandemic, the federal debt-to-GDP ratio averaged closer to 100%. That figure is now 120%. Fitch notes that this debt ratio is more than 2.5x higher than the median AAA-rated country.
Interest rates did move higher as a result of the downgrade; however, it was relatively muted. The 10-year US Treasury started the month at 3.97% and moved up to 4.34% by August 17th—but eventually moved lower to 4.09% at month end. The stock market impact was also limited, with the S&P 500 drifting down. Back in 2011, the stock market reacted much more negatively to S&P’s downgrade. The S&P 500 fell 13.9% in the third quarter of 2011 and had a drawdown close to 20% over those summer months. This time, the market had a 4.7% intra-month drawdown during August—showing little concern about the downgrade.
We did not make any allocation changes during the month. We noted in the July commentary that we are reviewing the potential rebalancing away from mega-cap growth stocks towards cheaper areas of the market. That review is still underway.
Over the years, the S&P 500 has become increasingly growth-oriented. Based on the Morningstar Style Box, the S&P 500 was 32.7% value, 37.6% core, and 29.7% growth at the end of 2019. This was a relatively balanced exposure to both growth and value. Since then, the S&P 500’s exposure has moved to 23.3% value, 35.9% core, and 40.8% growth (as of 6/30/2023). Growth has taken a meaningful share from value over the past few years. We are debating internally our comfort level having such a sizeable weight to growth stocks and an implicit overweight to growth in the context of a balanced portfolio. More to come.
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