Third Quarter Review 2023

By White Pine Wealth Management

Executive Summary

After an impressive display of resilience over the first half of 2023, the major U.S. indices fell in the third quarter, with the S&P 500 total return index falling -3.3% during the 3rd quarter, and falling -6.14% since its most recent peak on July 31st. Performance was worse down the cap scale, with the Russell 2000 index of small cap stocks falling -5.1% in the 3rd quarter. Results were mixed outside the U.S., but only two major developed markets posted quarterly gains. The Sensex (India) and the FTSE 100 (UK) advanced 1.7% and 1.0% respectively. At the other end of the spectrum, the Hang Seng (Hong Kong) and the DAX (Germany) fell -5.9% and -4.7% respectively.

• Bonds also faced stiff selling pressure that began in the 2nd quarter and continued through Q3. The U.S. 10-year Treasury yield rose from a low of roughly 3.3% in early April to nearly 4.6 at the end of the 3rd quarter, a level not seen since 2007.
• The weakness in stocks and bonds in the 3rd quarter was juxtaposed by rising oil prices and a steadily rising dollar. WTI Crude prices were up +28.5%, making Q3 of 2023 the best quarter for oil since the 1st quarter of 2022 – the quarter in which Russia invaded Ukraine.
• The recent weakness in equity returns can be attributed to increasing concerns over the strength of the U.S. consumer, which had been a key driver of economic and market growth over the first two quarters, and indications made by Federal Reserve Chairman Jerome Powell that interest rates may need to remain elevated for longer than expected to tame inflation.
• The markets have been quietly responding to these emerging concerns all summer. After rising impressively through much of the winter and spring, the S&P 500 index, which has been increasingly influenced by a small number of very large stocks, (known as the “FANGMAT” stocks), has been stumbling since the start of August. Between July 31st and September 26th, when this piece was written, the S&P 500 had declined -6.74%. In contrast—and not surprisingly, given the rise in the price of oil—the Energy Sector has advanced by 5.32% over the same time period, and has virtually been the lone success story lately, according to data provided by Black Diamond. Meanwhile, the bond market has been selling-off, with the 10-year Treasury yield rising from 3.28% on April 6th, to over 4.5% today.

An important takeaway from this data is that we have seen an abrupt switch in market leadership over the course of the last 2 months that has coincided with the aforementioned concerns about the strength of the consumer. The bond market has been broadcasting this message for most of the year, and the stock market has begun to follow suit.

Fourth Quarter Outlook 2023
Executive Summary

One of the more famous market euphemisms is that the markets tend to climb a ‘wall of worry’.  Reasons for investors to be worried are rarely hard to find but seem particularly abundant these days. Nevertheless, recession has remained elusive in 2023, as has a sharp market correction. No one can know exactly how the future will unfold and markets have a history of both shrugging off worrisome news (under-reaction) and also going through periods of panic (over-reaction). In markets like these, we must be willing to take what the market gives us. This could mean focusing on industries that thrive in the current environment, securing the best yields on bonds and cash in a generation, or simply maintaining target allocations to cash to take advantage of a selloff, if one occurs. As we move into the 4^th quarter of 2023, the investment landscape seemingly has more moving parts than usual. The following are some of the major themes and global developments that bear watching over the coming months.

• De-globalization and War: The World has become a more dangerous place since Russia invaded Ukraine on February 24, 2022. In addition to the ongoing conflict in Ukraine, war has erupted in Israel, Africa has experienced numerous military coups, and China has been increasingly making its presence known in the South China Sea with a rapidly expanding navy. Increasing tensions around the world can have many ramifications for investors, including increased government spending on military equipment and aid—a potentially inflationary development—and a continuing trend toward “onshoring” and “friend-shoring”, where the U.S. relies less on trade with China and more on domestic manufacturing and trade with close allies, such as Canada.

• Interest rates and Inflation: While the Federal Reserve has been able to bring inflation down considerably from its 2022 peak, Fed Chair Jerome Powell has indicated a determination to not repeat the policy mistakes of the 1970s, where rate hiking programs halted prematurely, allowing inflation to reignite. Meanwhile, the U.S. economy has remained strong enough to avoid a recession thus far in the rate-hiking cycle, thanks in large part to the strength of the labor market. While achieving a durable reduction in inflation without causing a recession is still possible (the so-called “soft-landing”), the resilience of the U.S. consumer, strength of the labor market, and rising energy prices, are all inflationary forces that increase the likelihood that more rate hikes will be necessary to fully tame inflation.

• Bonds: As interest rates have risen in response to the Federal Reserve’s efforts to curb inflation, yields on investment grade bonds are higher than they’ve been in a generation. While it is impossible to know if yields have peaked, the attractive yields on new fixed-income investments mean that coupon interest payments are likely to be a larger component of total return for bond investors than in the past. By extension, healthier interest payments could mean that bonds may provide a better buffer against stock market volatility than they have in the recent past.

• Energy: With war recently spreading to the Middle East, coupled with structural domestic constraints on supply, the price of oil and other energy sources could have an increased influence on consumer strength, economic growth, and geopolitical stability.

• U.S. Fiscal Health: Due to rising interest rates, the debt servicing costs for the U.S. Government are increasing for the first time in 35 years, according to data provided by Strategas. Nearly one-third of the outstanding U.S. Government debt will mature within the next year and will need to be rolled over at new, higher interest rates. The implications of a sharp increase in government interest expense would likely be reduced government spending on programs, increased taxes, expanding budget deficits, or some combination of the three.