October 2023
US Economy: Cooling inflation, job market.
The U.S. economy grew 2.1% in the 2nd quarter, with inflation moderating. For August, the Core PCE index rose just 0.1%, the smallest monthly increase in three years, putting annualized inflation at 3.9%, dramatically down from the highs of last year but still almost double the Fed’s 2% target. Meanwhile, an uptick in the unemployment rate (3.8%), labor strikes, and failure of Congress to agree on a federal budget hurt consumer confidence.
US Stocks: Large growth stumbles.
U.S. equities fell for the 2nd straight month, making Q3 a down quarter. With economic clouds on the horizon, valuations elevated, and earnings forecasts slipping, even the bulk of the “magnificent 7,” including Apple (-8.9%) and Nvidia (-11.9%), posted losses after driving most of 2023’s gains. As has been the case for much of this year, the more economically sensitive small-cap stocks were the weakest performers overall.
Foreign Stocks: Norway & India outliers.
International stocks outperformed the U.S., but were still down for Sept., with the 2.5% rise in U.S. dollar a drag. While foreign developed markets were almost unanimously down, Norway (+4.9%) was an outlier as oil production boosted energy stocks. In emerging markets, China (-2.8%) is facing a myriad of structural economic problems and potential deflation, while India rallied (+1.8%) as its GDP surged 7.8% year-over-year.
Fixed Income: Short maturities rule.
Money market funds and short-term fixed income were among the few bright spots in U.S. financial markets, with limited or no interest rate risk the driving factor. The yield on 10-year U.S. Treasury bonds rose nearly 0.5% in Sept. and sits near 4.7% in early October, a level not seen since 2007. With yields up, core taxable bonds fell 2% to 4% during the month, erasing 2023 gains. Mortgage rates (30-year fixed) rose above 8%.
Real Assets: Mixed bag.
The real assets category was not spared the pain felt in other asset classes. The dramatic increase in oil prices (WTI Crude hit nearly $90/barrel) and energy more broadly kept commodities in positive territory, but agriculture, grains, and precious metals were all down in line with equities. The renewable energy sector in particular is being hurt by rising operating costs while locked into supply agreements whose pricing is now below market rate.
Alternatives: Relatively OK.
Hedge funds found the middle road between stock and bond performance, modestly outperforming each. Managed futures strategies (+3.6%) were able to capitalize on persistent trends while market directional funds (-1.4%) unsurprisingly struggled a bit with deteriorating sentiment. Looking forward, a backdrop of higher interest rates is a potential tailwind for hedge funds as well as a number of private credit strategies.
Source of data: Bloomberg
Equities Total Return
| SEPT | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | (4.8%) | 13.1% | 21.6% |
| U.S. Small Cap | (5.9%) | 2.5% | 8.9% |
| U.S. Growth | (5.5%) | 23.8% | 26.6% |
| U.S. Value | (3.9%) | 1.6% | 14.0% |
| Int’l Developed | (3.4%) | 7.1% | 25.6% |
| Emerging Markets | (2.6%) | 1.8% | 11.7% |
Fixed Income Total Return
| SEPT | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | (2.5%) | (1.2%) | 0.6% |
| TIPS | (1.8%) | (0.8%) | 1.2% |
| U.S. High Yield | (1.2%) | 6.0% | 10.2% |
| Int’l Developed | (1.7%) | (0.9%) | (2.2%) |
| Emerging Markets | (0.8%) | 3.9% | 5.8% |
| Tax-Exempt | |||
| Intermediate Munis | (1.7%) | (0.9%) | 2.1% |
| Munis Broad Mkt | (2.8%) | (1.0%) | 2.9% |
Non-Traditional Assets Total Return
| SEPT | YTD | 1 YR | |
|---|---|---|---|
| Commodities | (0.7%) | (3.4%) | (1.3%) |
| REITs | (7.0%) | (5.6%) | (1.7%) |
| Infrastructure | (4.7%) | (3.7%) | 6.9% |
| Hedge Funds | |||
| Absolute Return | 0.9% | 1.7% | 1.4% |
| Overall HF Market | (0.0%) | 1.5% | 1.6% |
| Managed Futures | 3.6% | 2.0% | (2.8%) |
Economic Indicators
| SEPT-23 | MAR-23 | SEPT-22 | |
|---|---|---|---|
| Equity Volatility | 17.5 | 18.7 | 31.6 |
| Implied Inflation | 2.3% | 2.3% | 2.2% |
| Gold Spot $/OZ | $1848.6 | $1969.3 | $1660.6 |
| Oil ($/BBL) | $95.3 | $79.8 | $88.0 |
| U.S. Dollar Index | 122.0 | 119.5 | 127.4 |
Our Take
With three quarters now on the books, many of the more dire prognostications that economists had for 2023 remain unfulfilled: U.S. economic resiliency continues to surprise, inflation is slipping downward slowly, and the labor market hasn’t deteriorated meaningfully. Will the dire forecasts prove right at some point? Perhaps, since the impact of higher interest rates is finally starting to register.
Instead of focusing on the unknown, we continue to fine-tune portfolios for the likely shift in market regime we have discussed since the beginning of 2022: higher interest rates and inflation vs. the past decade, driven by pandemic and more recent trends that include: an ongoing shift toward reshoring (vs. globalization); U.S. organized labor reasserting its power; and rising uncertainty regarding U.S. fiscal policy as evidenced by the recent vacating of the Speaker of the House of Representatives.
Our approach is not one that leans into short-term bets, opting instead to build portfolios designed to perform through various market and economic environments toward long-term client objectives. The strong equity market in the first half of 2023, or “free lunch” as we called it at the end of June, provided an opportunity for portfolio rebalancing: trimming gains and adding to asset classes that had sold off. After the sell-off in most asset classes during Q3, rebalancing opportunities may be limited. Now is the time to exercise discipline and adhere to strategic asset allocations that target long-term goals, while making incremental adjustments to asset allocation to either reduce risk or increase return potential.
Please see our Q4 2023 Commentary, due out the third week of October, for an in-depth discussion of the major factors we see driving the markets and how we are positioning portfolios as a result.
