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October 3, 2023

Market Commentary: Q3 2023

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Q3 at a Glance

  • Third quarter markets reflected concerns over the “higher for longer” path for interest rates and uncertainty about the path of the economy.
  • Equity markets weakened to end the quarter leading to broad losses across regions, capitalization segments and industry sectors.
  • Interest rates rose steadily during the quarter, hurting fixed income returns in all but ultra short treasuries.
  • Progress continues to be made on bringing down inflation, but it is still far from the Fed’s target.

Uncertainty Rules in Q3

The third quarter ended on a weak note with investors digesting Fed signals that interest rates will likely remain “higher for longer”. Inflation signals continued to moderate, but remained well above the Fed’s 2% target. Economic conditions, especially labor markets, remained generally solid and gave hope to the growing expectations for an economic “soft landing”. Still, uncertainty in the interest rate, inflation and economic growth outlook remained high and caused stock and bond markets to fall broadly during August and September.

  • Equity markets declined across the board for the quarter, with the S&P 500 down 4.77% in September and off 3.27% for Q3.1
  • Interest rates rose steadily in September, with the 10-year treasury rate jumping about 50 basis points in September and almost 80 bp for the quarter.2
  • Rising rates dragged down returns for most fixed income sectors outside of the shortest duration treasuries.3
  • Inflation measures rose to end the quarter as oil prices jumped in August and September, but the core (ex food and energy) measures showed some improvement.4
Source: S&P Dow Jones Indices5, NASDAQ6

A Broad Sell-Off in Equities

  • All equity categories saw declines for the quarter after an especially weak September.7 
  • Economically sensitive small cap, value and emerging market stocks fared the worst, with small cap value stocks now negative for the year.8
  • Most industry sectors fell during the quarter.9 
  • Energy and communication services stocks were the only sectors to post positive returns for the quarter, with energy up 11.33% in Q3.
  • Utilities and real estate stocks were the weakest performers in Q3 and year to date.
  • The previously hot consumer discretionary and information technology sectors fell over 5% for the quarter.
  • No global region showed positive returns in Q3, but oil-rich Norway was a bright spot, posting gains of almost 12%.10
Source: S&P Dow Jones Indices

Rising Rates, Falling Returns for Fixed Income

Although the Fed held policy rates steady at their September meeting, other rates still rose across maturities. At the press conference after the September meeting, Fed Chairman Powell indicated that one more rate increase this year may be in the cards, stating that the expectation among Fed members is that, “If the economy evolves as projected, the median participant projects that the appropriate level of the federal funds rate will be 5.6 percent at the end of this year."11 

  • Fixed income returns were negative in all segments except ultra short term Treasury bills.12
  • Non-US government bonds and munis fell the most during the month.13 
  • The rise in long-term rates helped cut the “inverted yield curve” measure (10-year treasury yields less 2-year yields) by more than half (62 basis points) during the quarter14. A negative spread on this measure has historically been associated with a high risk of recession.

Inflation Scorecard

There has certainly been progress on bringing down inflation from the high levels in 2022. Surging oil and energy prices in August reversed steady declines in monthly changes seen in earlier months, with the CPI and PCE measures up 0.6% and 0.4%, respectively.15 16 Still, changes in prices from a year ago have come down noticeably. The Fed tends to focus more on “core” measures of inflation that exclude volatile food and energy prices. The Core Personal Consumption Expenditures price index for August released at the end of September showed a very low 0.1% change from July and a year-over-year rate of 3.9%, the first time it was below 4% since the current surge in inflation.17 Fed chairman Powell noted that “longer-term inflation expectations appear to remain well anchored, as reflected in a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets”.18 The table shows two of those measures: the year-ahead expected inflation rate implied in the TIPS markets and the University of Michigan Consumer Survey.19 20 The TIPS market based measure in particular shows a hopeful inflation outlook. Still, the Fed has indicated that the fight is not over and that further weakening in the economy is likely necessary to achieve their 2% year-over-year inflation target. That fight and outcome is what created the uncertainty and weak market returns in the third quarter.

Source: CPI: Bureau of Labor Statistics. Personal Consumption Expenditures: Bureau of Economic Analysis. TIPS Implied Inflation: Cleveland Federal Reserve Bank. University of Michigan.



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