July 2023
US Economy: Inflation slips.
While U.S. inflation is still above the Fed’s 2% target, price increases as measured by the Personal Consumption Expenditures Price Index (PCE) are down to levels not seen since 2021: 3.8% annualized; 4.6% minus food and energy. With gas prices down to $3.50/gallon recently vs. $4.80 a year ago, core inflation’s stickiness is likely driven by consumer demand as the unemployment rate remains a meager 3.7%.
US Stocks: Small caps join party.
Equity markets surged globally in June, capping off one of the best first halves in the last 25 years. U.S. equities most sensitive to the economy fared best. Among these, small-cap stocks were top performers, as headwinds from rising interest rates, banking system tumult and economic uncertainty seemed less ominous. Technology was outpaced by the consumer discretionary, industrials and materials sectors – up more than 10% each.
Foreign Stocks: Concerning inflation.
Foreign equity returns were generally positive in June, boosted by U.S. dollar weakness, although lagging U.S. markets for a variety of reasons. Inflation in Europe remains stubbornly high, especially in the U.K. (nearly 8% year-over-year), leading investors to price in a continuation of aggressive interest rate hikes. Emerging markets also underperformed the U.S. as China’s economic rebound has so far not been as strong as expected.
Fixed Income: High-yield bucks trend.
Interest rates rose quickly at the end of June, with the 10-year U.S. Treasury yield just below 4% in early July vs. around 3.5% in March. Bonds generally performed poorly in anticipation of the Fed resuming interest rate hikes in the months ahead to further curb inflation, as the U.S. economy remains resilient. High-yield bonds gained 1.6% on spillover enthusiasm from the equity markets and accelerated new issuance.
Real Assets: Almost all up.
Real assets have struggled through much of 2023, facing distinct headwinds from lower inflation and economic weakness. Signs of better-than-expected U.S. economic growth contributed to a June rally in real assets (3% to 6%), falling just short of the returns in the greater equity markets. Commodities contributed to that tally but remain the weakest performer year-to-date (-7.8%), with a 20% decline in the energy subsector the greatest detractor.
Alternatives: More of the same.
Hedge funds posted slightly positive results in June and in general have outpaced high-quality bond markets over the last year. Long equity-biased hedging strategies fared the best overall (+1.3%) but still sharply trailed straightforward equity holdings. Convertible bonds (+5.6%) were distinctly positive and may offer a uniquely attractive risk-return tradeoff as many of these hybrid securities are currently trading at attractive valuations.
Source of data: Bloomberg
Equities Total Return
| JUN | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | 6.6% | 16.9% | 19.6% |
| U.S. Small Cap | 8.1% | 8.1% | 12.3% |
| U.S. Growth | 6.9% | 28.0% | 26.6% |
| U.S. Value | 6.7% | 5.0% | 11.2% |
| Int’l Developed | 4.6% | 11.7% | 18.8% |
| Emerging Markets | 3.8% | 4.9% | 1.7% |
Fixed Income Total Return
| JUN | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | (0.4%) | 2.1% | (0.9%) |
| TIPS | (0.3%) | 1.9% | (1.4%) |
| U.S. High Yield | 1.6% | 5.4% | 8.9% |
| Int’l Developed | (0.2%) | 1.7% | (3.5%) |
| Emerging Markets | 0.5% | 3.9% | 6.5% |
| Tax-Exempt | |||
| Intermediate Munis | 0.6% | 1.2% | 1.6% |
| Munis Broad Mkt | 0.9% | 2.8% | 3.1% |
Non-Traditional Assets Total Return
| JUN | YTD | 1 YR | |
|---|---|---|---|
| Commodities | 4.0% | (7.8%) | (9.6%) |
| REITs | 5.4% | 3.0% | (4.4%) |
| Infrastructure | 3.0% | 3.8% | 4.2% |
| Hedge Funds | |||
| Absolute Return | 0.8% | 0.2% | 2.2% |
| Overall HF Market | 0.6% | 0.5% | 1.3% |
| Managed Futures | 1.2% | (0.4%) | (1.0%) |
Economic Indicators
| JUN-23 | DEC-22 | JUN-22 | |
|---|---|---|---|
| Equity Volatility | 13.6 | 21.7 | 28.7 |
| Implied Inflation | 2.2% | 2.3% | 2.3% |
| Gold Spot $/OZ | $1919.4 | $1824.0 | $1807.3 |
| Oil ($/BBL) | $74.9 | $85.9 | $114.8 |
| U.S. Dollar Index | 119.6 | 123.5 | 118.1 |
Our Take
Given strong returns in stocks and modest performance in bonds, 2023 seems to fit the mold of market behavior in the years after the 2008 financial crisis. However, the economic circumstances today are markedly different, with interest rates and inflation much higher and unemployment lower than in the recent past. Moreover, we’ve had three of the largest bank failures in history so far in 2023 and ongoing geopolitical conflict, both factors that can sink market sentiment. And yet, here we are with consumer confidence on the rise and markets following suit.
Have we escaped recession to find ourselves in the midst of another economic upswing? Probably not. The probability of recession remains elevated, with more interest rate increases expected by the Fed and signs of economic deterioration finally starting to take hold. Among them: U.S. manufacturing expectations have fallen to a post-Covid low (46 on the key ISM PMI Index); tighter bank lending; lower personal savings and higher delinquencies in both credit card and auto loans.
While 80% of U.S. homeowners have locked in long-term mortgage rates under 5%, somewhat blunting the effects of higher interest rates, businesses are typically funded with shorter-term loans that will be resetting at much higher rates in the coming years. The outcome, especially in sectors that are cash strapped already, is hard to predict. Our Q3 2023 Commentary, out later this month, focuses on the economic tug-of-war currently playing out.
What We Are Doing
In the near term, the reduction in credit available from banks and the corporate debt markets may lead to singular opportunities in private lending or distressed real estate debt for investors willing to establish strategic, likely less-liquid positions. Separately, we remain committed to infrastructure investments, which are supported by long-term societal needs and require both public and private funding.
Given the results we’ve seen so far in 2023, it’s easy to think the coast is clear. However, one of the hard learned lessons of investing is that the only certainty is uncertainty. The best strategy is almost always to refocus on the long-term objectives of each portfolio and consider changes in that light. Along those lines, higher interest rates mean that some clients may no longer need to take on as much risk to get the returns required to attain their goals. Others can benefit from the premium paid for illiquid investments when credit is tight. As the new market regime we are likely in unfolds, many new opportunities are arising that we are evaluating in light of each client’s circumstances.
