Staying the course!

Investment Advisory Research Center Q3 2023 commentary 

July helped get the third quarter of 2023 off to a strong start. However, the continued rise in interest rates—which sharply accelerated in September—proved to be too much for the equity markets to overcome, leaving both stock and bond market returns down approximately 4.0% and 3.0% respectively for the quarter. With markets now reversing their prior nine months of strong positive returns trends, it does provide advisors, and the investors they serve, the time to reflect upon and reaffirm their conviction and power of staying the course.

For example, the returns of stocks and bonds over the last seven quarters have been extreme, and oscillating, as seen in the scatter plot in Figure 1. The first three quarters of 2022 (blue dots) posted negative stock returns of –5.4%, –16.9%, and –4.4% and simultaneously negative bond returns of
–5.9%, –4.7%, and –4.8%. Then, in the fourth quarter of 2022, performance quickly—and very unexpectedly—flipped for the next three quarters (orange dots) with the stock market providing very positive returns of +7.2%, +7.2%, and +8.4%, opposite of what consensus experts were predicting at the time. Even bond market returns bucked the trend of rising Fed fund rates with returns of +1.9%, +3.0%, and –0.8%. 

Figure 1: Quarterly calendar year stock and bond returns (Q1 1928 to Q3 2023)

Past performance is no guarantee of future results. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Notes: Figure 1 shows the quarterly calendar year performance for each quarter going back to 1928. For 3Q23, performance is through September 26, 2023. For U.S. stock market returns, we used the Standard & Poor's 90 Index from 1926 through March 3, 1957; the S&P 500 Index from March 4, 1957, through 1974; the Dow Jones Wilshire 5000 Index from 1975 through April 22, 2005; the MSCI US Broad Market Index from April 23, 2005, through June 2, 2013; and the CRSP US Total Market Index thereafter. U.S. Bonds: IA SBBI U.S. Intermediate-Term Government Bond Index through 1972; Bloomberg U.S. Government/Credit Intermediate-Term Index from 1973 through 1975; Bloomberg U.S. Aggregate Bond Index thereafter.

Source: Vanguard Investment Advisory Research Center analysis using data from FactSet and Morningstar, Inc. Data as of September 26, 2023.

When zooming out to a longer-term view, one can see what a difference a year makes! Figure 2 shows the distribution of year-to-date returns for stocks, bonds, and a balanced 60% stock and 40% bond portfolio (60/40 portfolio). Last year on September 30, 2022, year-to-date returns for stocks, bonds, and a 60/40 portfolio delivered negative returns of –24.9%, –14.6%, and –20.7% respectively. One year later, as we approach September 30, 2023, the year-to-date returns for stocks, bonds, and a 60/40 portfolio as of September 26th are +11.7%, –1.0%, and +6.6%, respectively. What a difference a year makes!

 Figure 2: Distribution of year-to-date returns (1928-2023)

Stocks

Bonds

60% stocks and 40% bonds

Past performance is no guarantee of future results. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Notes: Figures 2a.–c show the cumulative year-to-date performance from January through September of each year going back to 1928. For year-to-date 2023, performance is from January through September 26, 2023. For U.S. stock market returns, we used the Standard & Poor's 90 Index from 1926 through March 3, 1957; the S&P 500 Index from March 4, 1957, through 1974; the Dow Jones Wilshire 5000 Index from 1975 through April 22, 2005; the MSCI US Broad Market Index from April 23, 2005, through June 2, 2013; and the CRSP US Total Market Index thereafter. MSCI US Broad Market Index through June 2, 2013; CRSP US Total Market Index thereafter. U.S. bonds: IA SBBI US Intermediate-Term Government Bond Index through 1972; Bloomberg U.S. Government/Credit Intermediate-Term Index from 1973 through 1975; Bloomberg U.S. Aggregate Bond Index thereafter. 60-40: weighted 60% U.S. stocks and 40% U.S. bonds.

Source: Vanguard Investment Advisory Research Center analysis using data from FactSet and Morningstar, Inc. Data as of September 26, 2023.

While you may not remember how you were feeling a year ago, let’s quickly recap what was happening in the markets:

• Balanced investors had just experienced the second worst decline in history (–20.7% for a 60/40 portfolio, second only to the year-to-date performance of –23.5% through September 1974).
• Consumer sentiment was nearing or at historical lows, as seen in Figure 3.
• Inflation, forecasted as transitory by the experts, was still rising and at 15-year highs.
• The average forecast for the S&P 500 Index, as reported by Bloomberg, called for a negative return in 2023—the first time since at least 1999¹.

Given this backdrop, clients de-risking their financial portfolios could have been expected. Equity allocations holding steady while sentiment is low differs from past patterns where equity allocations and sentiment had a closer relationship.

Figure 3: Consumer sentiment and equity allocations

Notes: Figure 3 shows consumer sentiment relative to equity mutual fund and ETF assets as a percentage of total fund and ETF assets from January 2005 through July 2023. Consumer sentiment: The University of Michigan Consumer Sentiment Index, Not Seasonally Adjusted. Equity allocations: Total equity mutual fund and ETF assets as a percentage of total fund and ETF assets.

Source: Vanguard Investment Advisory Research Center analysis using data from the Saint Louis Federal Reserve Database and Morningstar, Inc. Data as of July 2023.

Despite these traditionally strong emotional and behavioral headwinds, equity allocations continued to stay the course as seen in Figure 4². In our view, this “stay the course” behavior can be at least partially attributable to advisors successfully helping their clients to tune out the noise, acting as “emotional circuit breakers” and influential behavioral coaches.

Figure 4: Aggregate industry asset allocations from January 1993 to August 31, 2023

Notes: Figure 4 shows the change in equity, bond, and money market mutual fund and ETF assets as a percentage of total fund and ETF assets from January 1993 through August 2023. The line illustrates current equity allocation (60.3% as of August 31, 2023) to visualize the variance of equity allocations (aqua blue bottom area) through time.

Source: Vanguard Investment Advisory Research Center analysis using data Morningstar, Inc. data as of August 2023.

We commend advisors and investors for staying invested; tuning out poor market returns, negative sentiment, and forecasts; and staying laser-focused on their investment horizons and objectives. While this is often a difficult task—given all the hype about where the market might be going—this is truly where the advisor, acting as a behavioral coach, can exponentially earn their fees! However, too often, this value does not show up on a client’s quarterly investment statement. To help your clients understand the “off statement” value-added, consider having “remember when” conversations.

For example, if your client had $1 million in a balanced 60/40 portfolio³ and just experienced a nine-month loss of almost 21%, the second worst in history, and in your third quarter 2022 quarterly meeting your client wanted to abandon their allocation and go to money markets now yielding more than 3% for the first time in fifteen years—and you were able to coach them into staying the course—you would have saved this client almost $60,686 as seen in Figure 5. This savings is the difference between $892,092, if they had remained invested versus, $831,406 had they moved to money markets.

Figure 5: Impact of staying the course versus bailing to cash

January 1, 2022, to September 26, 2023

All investing is subject to risk, including the possible loss of the money you invest. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Notes: Stock allocation consists of 100% U.S. equity and is represented by the CRSP US Total Market Index. Bond allocation consists of 100% U.S. fixed income and is represented by Bloomberg U.S. Aggregate Float Adjusted Index. Cash is represented by the FTSE 3-Month US T-Bill Index.

It is always critical to remember that there are an infinite number of alternate histories that might have happened had we made different decisions; yet we most often only measure, or monitor, the implemented decision and outcome even though the other histories were real alternatives. For instance, most client statements do not keep track of the benefits of talking your clients into “staying the course” during a bear market or convincing them to rebalance when it doesn’t feel like the right thing to do at the time. We do not measure and show these other outcomes, but their value and impact on clients’ wealth creation is very real, nonetheless. This is why it is critical to discuss with your clients, the “off statement” value-add that comes from your expertise in behavioral coaching, tax alpha, retirement income drawdown, rebalancing, and many other areas where you add value for your clients on an ongoing basis.

Given the extreme and oscillating quarterly returns of stocks and bonds over the last 21 months, and with recency biases of this quarter’s market pullback, accelerating in September, now is a great time to engage in “remember when” conversations. To support you in having these conversations, we developed the Market Hindsight Tool where you can custom create similar analyses. We are committed to helping you to quantify and articulate the value you create for your clients. Please feel free to engage with our Behavioral Coaching Toolkit, Advisor’s Alpha hub, or sales teams.

We commend you on helping investors stay the course, despite so many headwinds!

1 Bloomberg, 2022. Wall Street Turns Bearish on Stocks After Bad Year. December 1, 2022.

2 For more information, see Vanguard’s Midyear 2023 Risk speedometers: What are allocators buying and selling?.

3 $1 million portfolio value on 1/1/2022.

Notes:

All investing is subject to risk, including possible loss of principal.

Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Past performance is not a guarantee of future results.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.