Good Riddance to a Bad Quarter. Or Was It?

Today marks the end of this year’s third quarter. The general sentiment is far less ebullient than it was just a few weeks ago. In the past few weeks, inflationary pressures have increased and the Federal Reserve has indicated a policy stance that promises to be less accommodative. The fiscal situation as Congress debates ways to keep the government open and avoid a default, with stimulus measures bogging down in a political morass. Major stock indices have been under pressure, while bond yields have been rising steadily. What a dire quarter this has been.

Or has it? Let’s take a look at the actual numbers, using data through yesterday’s close:

Source: Bloomberg and IBKR

Does this look like a horrible quarter to you? On a percentage basis, the worst performer is the 2-year note yield, but it is only up about 4 basis points in actual terms. The hand-wringing about higher long-term rates seems overblown, with 10-year yields less than 5 basis points higher and 30-year yields actually 2.5 basis points lower. Major US stock indices were mixed, with small gains in the S&P 500 (SPX) and Nasdaq 100 (NDX) indices, and only minor losses in the Dow Jones (INDU) and Russell 2000 (RTY). Meanwhile, bitcoin posted a double-digit gain.

Why the gloom, then? I suspect it has more to do with recent drawdowns than the quarter-to-date results overall. Human decision-making often suffers from recency bias, a phenomenon that can cause people to overweight more recent events than those that occurred longer ago. Let’s take a look at the drawdowns from the quarter’s highs that have occurred (yields inverted):

Source: Bloomberg and IBKR

We can see that some of the quarter’s highs — all-time highs in the case of SPX, NDX – were achieved earlier this month. By historical standards, drawdowns of 4-6% in equities are not atypical, though by recent standards they seem large. Over the past 18 months, we have been lulled into the notion that stocks rise steadily and rarely suffer 5% pullbacks, let alone 10% corrections. This is recency bias at work. This month’s pullbacks seem large within the context of recent experience, but not over a broader history. 

That said, the turnaround in 30-year yields is rather stunning since the quarter’s low yield was reached just over a week ago. Treasury note yields bottomed for the quarter in early August, though the rise in rates accelerated over the past few weeks. Despite the rising yields, '10s and ’30s are not yet approaching the high levels seen at the end of this year’s first quarter. Even bitcoin, which has lost a quarter of its value in about 3 weeks, has only receded to the midpoint of its recent trading range.

As I write this, equity markets are generally lower but still up for the quarter. The recent declines may feel large, but they should be well within the risk tolerance of a well-managed investor. As I’ve cautioned before, if a relatively minor drawdown is causing you angst, then you should be considering whether you should be reducing the risk in your portfolio. We have noted that some of the “givens” behind recent investment themes – such as relentless monetary and fiscal stimuli – may be coming to an end. That could lead to some volatility as investors reassess these changes. As we finish what turned out to be a relatively benign quarter, investors should take the prudent step of reassessing their risk exposures and tolerance amidst a less certain investment climate.