US Equity markets rose to their highest levels since March of 2022 early in the third quarter, but rising global bond yields, fears of a rebound in inflation, and concerns of a future global economic slowdown all weighed on the major market indexes in August and September. Markets finished lower for the full quarter after a strong first half of 2023.
For the full quarter, the S&P 500 fell -3.27%, the Dow Jones industrials fell -2.10% and the Nasdaq Composite was down -3.94%. International markets were also negative, as the MSCI/ACWI Index declined -3.69%, as well as the fixed income markets, with the Barclays Aggregate Bond Index down -3.23% for the full quarter.
Stalling disinflation, rising bond yields, and an uncertain global economic outlook set the stage for a choppy market backdrop during the third quarter, despite solid economic and corporate activity. While most stock and bond categories declined, rising oil prices pushed commodities and energy stocks higher. Bond yields rose above their long-term historical averages, causing interest-sensitive assets to decline the most. Increased uncertainty about inflation raised the odds of higher market volatility, amid global monetary tightening and dampened market liquidity. At the end of the quarter, many investors expected that global policy rates had reached their peaks and could ease in the coming quarters.
All this being said, the impact of the abrupt departure from the ultralow rates era could still weigh on financial conditions in the quarters to come. The resilient US late-cycle expansion coincided with a pause in disinflationary trends, another Fed rate hike, and rising long-term Treasury-bond yields. The late-cycle phase of the business cycle warrants increased caution, portfolio diversification, and a readiness for opportunities.
Markets begin the fourth quarter decidedly more anxious than they started the third quarter, but it’s important to realize that while the S&P 500 did hit multi-month lows in September, and there are legitimate risks to the outlook, underlying fundamentals remain generally strong.
First, while there are reasonable concerns about a future economic slowdown, the latest economic data remains solid. Employment, consumer spending and business investment were all resilient in the third quarter, and there simply is not much actual economic data that points to an imminent economic slowdown. So, while a future economic slowdown is certainly possible given higher interest rates, the resumption of student loan payments, and declining US savings, the data has yet to bear that out.
Second, fears that inflation may bounce back are also legitimate, given the rally in oil prices in the third quarter. The Federal Reserve and other central banks typically look past commodity-driven inflation, however, and instead focus on core inflation; that metric has continued to decline throughout the third quarter. Additionally, declines in housing prices from the recent peak are only now beginning to work into the official inflation statistics, and that should see core inflation continue to move lower in the months and quarters ahead.
Finally, regarding monetary policy, the Federal Reserve’s historic rate hike campaign is nearing an end. While we should expect the Fed to keep rates higher for longer, high interest rates do not automatically result in an economic slowdown. Interest rates have merely returned to levels that were typical in the decades past, before the financial crisis, and the economy performed well during those periods. While the risk of higher rates causing an economic slowdown is one that must be monitored closely, for now, higher rates are not causing a material loss of economic momentum.
In sum, there are real risks to both the markets and the economy as we begin the final three months of the year, but these are largely the same risks that markets have faced throughout 2023, and over that period the economy and markets have remained impressively resilient. While these risks and others must be monitored closely, they don’t present any new significant headwinds on stocks that haven’t existed for much of the year.
As we begin the final quarter of 2023, we remain vigilant towards economic and market risks and are focused on managing both risk and return potential. We remain firm believers that a well-prepared, long-term focused and diversified financial plan can withstand virtually any market surprise and related bout of volatility, including higher-for-longer interest rates, stubbornly high inflation, geopolitical tensions, and recession risks.
We understand these risks, facing both the markets and the economy, and are committed to helping you effectively navigate this challenging investment environment. We continue to believe that the strategies we manage are comprised of companies that are well-positioned for long-term success, are well run by capable management teams, and that their ownership over time will lead to positive outcomes.
As always, we will remain patient and stick to the long-term plan, as we have worked with you to establish a unique, personal allocation target based on your financial position, risk tolerance, and investment timeline. We thank you for your ongoing confidence and trust. Please rest assured that our entire team will remain dedicated to helping you accomplish your financial goals. Please do not hesitate to contact us with any questions, comments, or to schedule a portfolio or financial plan review.
Joseph P. Biondo
CEO, CIO, Portfolio Manager
Sources: Index returns – Bloomberg; Market Commentary – Wall Street Journal, Barron’s