At Nixon Peabody Trust Company, we continuously evaluate real-time economic data and short- and long-term forecasts to build customized strategies that grow your money. If the flood of financial headlines leaves you a bit confused, you can be confident that we’ve designed a portfolio-positioning strategy to maximize your success.
Q3 2023 in review
The S&P 500 Index reached its high for the year on July 31 but declined in August and September. September’s decline of 4.77% in the S&P 500 caused year-to-date returns to fall to 13.06%. Bonds were also weaker during Q3, with 10-year Treasury yields reaching their highest level since 2007. Crude oil prices rose more than 28%, boosting energy stocks but hurting consumer purchasing power.
| Q3 | YTD | |
| Equity | ||
| MSCI All Country World Index | -3.30% | 10.49% |
| S&P 500 Index | -3.27% | 13.06% |
| NASDAQ Composite Index | -3.94% | 27.11% |
| Russell 2000 Index | -5.14% | 2.51% |
| MSCI EAFE Index | -4.04% | 7.63% |
| MSCI Emerging Markets Index | -2.85% | 2.07% |
| Fixed Income | ||
| Bloomberg Aggregate Index | -3.23% | -1.21% |
| Bloomberg 1-5 Year Gov/Credit | 0.21% | 1.40% |
| Bloomberg Municipals | -3.95% | -1.38% |
| Bloomberg 3-Month T-Bill | 1.33% | 3.72% |
Energy and communications services were the only S&P 500 sectors with positive performance in Q3. Utilities and real estate—two sectors sensitive to high interest rates—were the worst performers.
US small company stocks were also weak performers during Q3 and trail large-cap stocks significantly year-to-date. Non-US stocks also declined during the quarter.
Recession watch
Many economists expected the US economy to enter a recession in 2023, but some would now argue that it experienced a soft landing in which recession was avoided. The recently released October jobs report showed continued resiliency in September, with 336,000 jobs added during the month. However, soft landings do not last forever.
Although economic growth has been more resilient than expected, the two most likely paths for the global economy would end in recession. One potential path is for the lagged effect of rate hikes to tip the economy into recession. Another potential path is for the economy to overheat if it cannot keep pace with growing demand, causing a second wave of inflation and further tightening of monetary policy. The paths may be different, but the result for both would be recession.
There are reasons to expect a mild recession rather than the severe recessions and bear markets experienced in 2001, 2008, or 2020. Consumer balance sheets are in good shape, with household debt and debt servicing ratios far below the heights reached during the global financial crisis. The housing market is slowing, but in contrast to 2008, lending standards are much stronger, housing inventories are lower, and most US mortgages are fixed rate rather than adjustable. Although consumer spending may slow in response to higher oil prices and the resumption of student loan payments, it is unlikely to collapse if the job market remains reasonably strong.
Interest rates
Investors responded poorly to indications that rates will stay higher for longer, remaining near 15-year highs. There is a growing awareness that the end of the journey to get inflation back to target may be the most difficult part. Longer-term bond yields rose to a greater extent than short-term yields in Q3. The Federal Reserve and foreign central banks, previously reliable buyers of US government debt, have become less active buyers. With more than 50% of America’s outstanding debt maturing in the next three years, long-term yields have adjusted to reflect a new environment for bond investors.
International markets
Chinese economic growth has disappointed investors who expected a strong post-pandemic rebound as the country re-opened. Structural challenges include weakness in the property sector and high rates of youth unemployment. Recent policy support has not been enough to boost growth or reverse negative investor sentiment. Although China faces significant structural challenges, there are opportunities in segments of the market supported by the government, including electric vehicles, healthcare, and industrial automation. Emerging markets outside of China may benefit from companies seeking to diversify supply chains, the rise of the middle-class consumer, and the transition to greener manufacturing and transportation structures.
European stocks are also suffering from negative sentiment, with inflation remaining above central bank targets, exports to China falling, and natural gas prices remaining a big challenge for German manufacturers. However, the outlook for Europe also contains some bright spots. In the near term, consumers with savings accumulated during the pandemic may be inclined to increase spending. Longer term, there are opportunities among European stocks that are global market leaders, including luxury goods brands, enablers of the green manufacturing and transportation transitions, and suppliers to countries that need to spend a larger amount on national defense.
Portfolio positioning
Although the market, as measured by the S&P 500, remains up year-to-date, the market rally has been driven by a small number of stocks. To illustrate, an equal-weighted index of S&P 500 stocks returned 1.8% through September, compared to 13% for the index overall, highlighting the top-heavy composition of the calendar year returns.
We have reduced our holdings in some of this year’s big winners, as some of the upside we expected was pulled forward by investor exuberance in the first seven months of the year. Volatility often creates buying opportunities for long-term investors, and there are compelling investment options among the stocks left behind in this year’s narrow rally. We are emphasizing stocks that may be more resilient in uncertain economic times, with balance sheet strength and the ability to grow market share and participate in growing end markets. We have added positions in the materials and healthcare sectors that combine favorable long-term growth dynamics with reasonable valuations.
Weakness in the bond market is also creating compelling investment opportunities. With inflation easing and interest rates at their highest levels since 2007, high-quality short- and intermediate-term bonds are an important segment of investor portfolios. We are looking for opportunities to secure higher rates by selectively investing in intermediate-term bonds, as today’s high money-market rates may not last indefinitely.
If you have questions or comments—about your personal portfolio or any of the trends and strategies we’ve outlined here—please reach out to us or any member of your Nixon Peabody Trust Company team. We’re always happy to hear from you.