Watch the Video: Q3 Reflections with Abacus CIOs
In our latest third quarter reflections webinar, Co-Chief Investment Officers Lindsey Woodward and Matt Rivera explore market performance in Q3 2023, energy sector fluctuations, the impact of Artificial Intelligence, interest rates, and the significance of rebalancing your portfolio.
A History of Markets Through Difficult Times
There are many challenging and heartbreaking realities in the world. While Abacus’ focus is primarily through a financial lens, we never want to minimize or forget the genuine suffering so many of our fellow humans endure. The way we approach investing continues to be as mindful as possible to help effect as much positive change in the world that we can realistically bring.
Peering through that financial lens then, the markets are often marked by uncertainty and the headlines can indeed be intimidating. In today’s world, it’s easy to feel apprehensive about both global events and your investment portfolio. In these moments, it’s crucial to remember that history has shown us that despite short-term turmoil, the markets have historically rewarded systematic, long-term investment strategies.
Consider the timeline in Exhibit 1 that spans from 1970 to the end of 2022. It paints a picture of the market’s resilience throughout various crises, such as the Y2K scare, Hurricane Katrina, and multiple wars. Even in the face of such adversities, the market continued to grow, rewarding investors who remained committed to their investment strategies.
This historical perspective serves as a reminder that while the current times may be challenging and anxiety-inducing, history teaches us that staying invested during turbulent periods can lead to long-term financial success.
Q3 and Year-to-Date Stock Market Review
The third quarter of 2023 presented several challenges for the stock market. Across the board, stock indices experienced declines. This decline is notable when we examine the performance of different asset classes during the quarter.
In the U.S., large-cap stocks fared better compared to small-cap stocks, while value stocks showed a marginal outperformance against growth stocks. However, these percentages did not reflect the full picture of the past year.
When considering the performance over the past year, the narrative changes. Large growth companies – largely due to the “Magnificent Seven” – led the way in the U.S. stock market, outperforming their value counterparts. Interestingly, this trend is the opposite outside the U.S., emphasizing the importance of diversification in an investment portfolio.
Despite the challenging third quarter, the last year has demonstrated robust performance in the markets, highlighting the long-term benefits of a well-diversified portfolio.
Q3 and Year-to-Date Bond Market Review
During Q3, the Federal Reserve raised interest rates in July to a 22-year high range of 5.25% to 5.5%. In September, rates remained steady, but the bond market was not immune to these changes.
The Bloomberg U.S. Aggregate Bond Index returned -2.54% in September and -3.23% for the third quarter. This decline illustrates the sensitivity of bond prices to interest rate fluctuations.
As depicted in Exhibit 4, the past 15 years have been characterized by historically low interest rates following the Great Recession. Currently, rates are moving closer to their long-term averages. While rising rates can be a hindrance for borrowers, long-term investors in the bond market can find opportunities, even if they experience short-term pains.
Bond prices drop with rising interest rates due to a concept known as opportunity cost. However, in rising rate environments bonds, especially those held alongside thousands of others in diversified mutual funds, allow investors to benefit from the strategic reinvestment in higher-yielding bonds as existing bonds mature and distribute income.
Notably, Abacus’ bond model portfolios have seen their yield to maturity more than double in the past two years due to strategic reinvestment in higher-yielding bonds. This is an example of how a well-structured investment approach can transform challenges into opportunities.
Energy Sector Insights
The energy sector’s performance in the third quarter was a stark contrast to its prior underperformance in the first and second quarters of 2023. Over the past two calendar years, energy has managed to outperform, but this comes after a challenging stretch, with poor performance in five of the eight years leading up to 2020.
The energy sector’s performance serves as a reminder that diversification is essential, as specific sectors can exhibit significant volatility, impacting investment portfolios.
Rebalancing and How It Works
Diversified portfolios consist of various asset classes, each with its own risk-return profile. These asset classes do not move in tandem, causing portfolios to drift away from their target allocations. At Abacus, we monitor our client portfolios attentively and employ strategic rebalancing to realign them with their intended asset allocation.
This fundamental practice ensures that portfolios maintain the desired risk profile and adhere to long-term financial goals. To maintain a simplified example of what’s happening in Abacus portfolios, imagine a portfolio’s target allocation is 60% stocks and 40% bonds. If stocks outperform bonds and shift the allocation to 70% stocks and 30% bonds, a rebalance is necessary. This process involves selling stocks and buying bonds to restore the portfolio’s desired 60/40 allocation.
Diligent portfolio monitoring and strategic rebalancing play a crucial role in keeping investments on track, particularly during turbulent market conditions.
AI in Finance
Artificial Intelligence (AI) is a subject of growing interest and concern in the financial world. To explore more, we invited Gabe Brenner, an Abacus advisor and investment committee member, to share his insights on AI in the context of finance. Gabe recently published three blogs on the impact of AI in finance including, “Artificial Intelligence, Your Portfolio, and Our Future,” “How a Chatbot Explains Financial Theory,” and “Financial Advisor vs. AI – Who Gets it Right?” During our discussion, Gabe shed light on some pressing concerns.
What are the risks of present-day AI?
Gabe highlighted several risks associated with present-day AI. First, he mentioned the risk of automation and job displacement, particularly for those in clerical or administrative roles. AI’s ability to automate certain functions within jobs could lead to job loss in specific sectors. However, he also emphasized that this isn’t a new phenomenon and has been observed throughout history with technological advancements. He stressed the importance of preparing for these changes and focusing on the net benefits of AI for productivity and economic growth.
Another risk Gabe discussed is the potential for AI to propagate disinformation. AI, particularly in generating text and images, could be used to spread misleading information, which can have consequences, especially in sensitive areas like geopolitics. Additionally, AI has the capacity to learn from historical data, which includes prejudices present in human data. As a result, AI systems can inadvertently reinforce these biases. He underscored the significance of ensuring that AI aligns with humanity’s needs to mitigate these risks.
What does AI mean for your investment portfolio?
Gabe indicated that AI will likely change the investment landscape. He mentioned Nvidia, a company that designs computer chips, which has seen its stock rise due to its chips’ relevance in AI applications. However, he cautioned that predicting which companies will be the future winners in the AI industry is challenging. While some companies may initially possess an advantage, that advantage often dissipates as others catch up. Despite potential productivity enhancements from AI, predicting specific stock market outcomes related to AI remains highly fraught.
How could AI impact the finance industry?
Gabe’s response highlighted that AI’s role in the finance industry could bring changes. While he didn’t foresee AI enabling accurate market predictions, he suggested that AI’s primary impact in finance would be on data analysis and administration. AI’s data-processing capabilities could increase productivity in areas like financial analysis. However, as it pertains to portfolio management, he noted that the dynamic and unpredictable nature of financial markets doesn’t align well with the stable patterns that AI typically relies on for making predictions. He also emphasized that the primary concern should be ensuring that AI aligns with humanity’s interests, highlighting the importance of ethical and regulatory considerations.
In summary, the dual nature of AI’s potential, offers both risks and opportunities in various domains, including employment, information accuracy, and financial markets. It is vital for investors to stay informed and adapt to the evolving landscape where AI plays an increasingly significant role.
We’re Here for You
The market’s history is a testament to its resilience, and while challenges may arise, those who remain committed to their investment strategies tend to achieve financial success over the long term. As we navigate market changes, Abacus continues to stand by our commitment to provide clients with sound, data-driven advice to help them achieve their financial goals.
We encourage investors to focus on their objectives and stay the course, remembering that market fluctuations are part of the journey. Your financial well-being is our top priority, and we remain dedicated to assisting you in your journey to financial success.
If you have further questions or need personalized advice, don’t hesitate to reach out to your Abacus advisor or schedule a call. In a world filled with financial complexities, having a trusted advisor can make all the difference in serving your unique needs.
Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your Abacus account holdings correspond directly to any comparative indices or categories.
Please Note: (1) performance results do not reflect the impact of taxes; (2) comparative benchmarks/indices may be more or less volatile than your Abacus accounts; and, (3) a description of each comparative benchmark/index is available upon request.
Please Also Note: This material is not intended to serve as personalized tax and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Abacus Wealth Partners is not an accounting firm. Please consult with your tax professional regarding your specific tax situation when determining if any of the mentioned strategies are right for you.