Aldrich Wealth Partner Nicole Rice and Chief Investment Officer Darin Richards offer market commentary and projections every quarter. This includes a discussion on market performance in the third quarter of 2023 and what to anticipate throughout the remainder of the year.

The S&P slipped -3.3% over the third quarter of 2023, giving back some of the gains experienced in the first half of the year. Nearly all underlying sectors of the index fell as companies felt the pain of higher interest rates. The Fed raised interest rates once during the quarter and signaled the intention to keep rates higher for longer. International markets outpaced their domestic counterparts in local terms but trailed as returns were adjusted for the rising value of the dollar, with the MSCI EAFE posting a -4.1 % loss on the quarter. Emerging markets, as measured by the MSCI Emerging Markets Index, fell -2.9% in Q3 as several poor economic data were published in China. As interest rates rose, fixed-income markets continued to struggle, with the Bloomberg US Universal posting a loss of -2.9% over the third quarter of the year. Economic data were mixed throughout the past three months, with GDP and consumer spending increasing but delinquencies hitting record levels. Although it looked like the labor market might have started to show signs of weakness earlier on, it remained resilient throughout Q3. Looking forward, we anticipate both stocks and bonds could produce more attractive returns than they have exhibited in the past couple of years if the Fed ends the rate hiking cycle soon. If the Fed reverses course and continues the rate hiking cycle for longer, we would anticipate more volatile markets.

The S&P 500 slid -3.3% during the third quarter of 2023 after gaining in the first half of the year. Although July kicked the quarter off on a positive note, August and September unfolded amid more concerning economic conditions. Inflation continued to trend downward, but Q2 GDP came in ahead of expectations, powered by consumer spending. Consumers are spending at the fastest pace since the Great Financial Crisis but are struggling to pay off loans, represented by record levels of credit card and auto delinquencies. Housing prices persisted at high levels, and concerns around the financial sector waged on as Moody’s downgraded six banks. The Fed raised interest rates by just 25 basis points throughout the quarter stuck to the higher-for-longer theme, signaling one more hike this year before modest rate cuts in 2024. Treasury yields rose, with the 10-year yield reaching the highest level in 16 years as stronger-than-expected jobs data were published.

Just two of the eleven underlying sectors in the S&P 500 rose during the quarter. Energy posted double-digit gains on the heels of rising gas prices, and communication services rose thanks to increased revenue generated by streaming services. Conversely, utilities and real estate posted the worst returns of the quarter, driven down by the effects of rising interest rates.

Large-cap stocks once again outpaced small-cap stocks throughout the quarter. While growth stocks eked out a 3-basis-point-lead over value stocks in the large-cap market, value stocks significantly outperformed growth stocks in mid- and small-cap markets (by 9.3% and 5.8%, respectively). In a reversal of the first half of the year, small-cap value stocks posted the best performance of Q3.

Like their domestic counterparts, international developed markets struggled throughout the third quarter, and returns were further dampened by the dollar’s increasing strength. While the MSCI EAFE Index beat out US equities in local terms, the index posted a quarterly loss of -4.1% once adjusted to dollar-denominated terms. Within the Eurozone, inflation cooled throughout the quarter, dropping to the lowest level in two years but persisting well above the European Central Bank (ECB)’s target. The ECB raised interest rates to a 23-year high in July but paused in September, noting that rates have not necessarily peaked and additional hikes may be necessary. European government bond yields climbed throughout the quarter as revised data showed the Eurozone narrowly avoided a recession in Q1 and began to expand in recent months. Within the UK, the Bank of England raised interest rates to a 15-year high, reaffirming the commitment to hold rates higher for longer. Housing prices fell at the fastest pace since 2009 during Q3, but GDP exceeded expectations. In Japan, the Bank of Japan increased flexibility around its yield curve control target, and the 10-year yield rose to the highest level in over a decade. Inflation fell throughout the quarter, and the yen weakened to an 11-month low.

Elsewhere, the MSCI Emerging Markets Index slipped -2.9% during the third quarter. Data published throughout the quarter showed signs of China’s weakening economy. Q2 GDP disappointed, growing just 0.8%, and youth unemployment jumped to a record 21.3% as the technology and real estate sectors that employ many recent graduates have failed to recover post-pandemic. Exports fell to the lowest level since the onset of COVID-19, and top-ranking officials pledged to boost domestic consumption and strengthen the post-COVID recovery but took no specific action. During the quarter, consumer and producer prices fell concurrently as retail spending and manufacturing production slowed, and household debt surged to 1.5 times that of income. India, on the other hand, was the index’s best-performing country of the quarter as the economy continued to display strong signs of growth.

Over the third quarter of the year, the Bloomberg US Aggregate Index fell -3.2%, and the broader Bloomberg US Universal Index slid -2.9% as the Fed reaffirmed its higher-for-longer theme and signaled an additional rate hike this year. Year-to-date returns for the indexes have now fallen into negative territory and respectively stand at -1.2% and -0.6%.

The yield on the 10-year US treasury increased 0.8% during the quarter, ending at 4.59% after falling slightly at the beginning of the quarter. The yield curve remained inverted, with the 2-year yield persisting above the 10-year yield. Short-duration yields, which are closely tied to Fed rate moves, rose higher, too, with the 2-year treasury increasing by 16 basis points and ending the quarter at 5.03%. Although the inverted yield curve continues to indicate a mild recession, future rate cuts have been pushed into 2024 as the employment situation remains strong and inflation is slowly declining. Credit spreads narrowed during the quarter as the Fed inched closer to ending rate hikes, and the economy remained resilient.

US gross domestic product (GDP) grew at an annualized rate of 2.1% over the second quarter of 2023, the latest period for which data are available. Once again, consumer spending drove this increase. Robust spending drives GDP higher, but delinquencies are reaching record levels as consumers spend faster than they save, which could spell trouble for the economy going forward. Inflation continued to trend downward in Q3 but remains elevated above normal levels.

The tight labor market started to show signs of weakening throughout the third quarter of 2023. Job growth cooled in July, reaching the weakest monthly gain since December 2020. In August, the labor market seemed to rebound, with unemployment claims coming in well below expectations and job openings unexpectedly rising. September data, however, showed that private payroll growth fell sharply. The labor market has remained extremely resilient in the face of elevated inflation and rising interest rates, but as it starts to loosen, it could provide the Fed incentive to stop raising interest rates.

Inflation has been trending downward (though it had a slight uptick in July, as expected) but remains far above the Fed’s target. The Fed is projecting slightly higher unemployment rates, which should contribute to receding inflation. Although Jerome Powell and team only raised interest rates by 25 bps during Q3, they stuck to the higher-for-longer theme and maintained a slightly hawkish tone, signaling one additional hike this year before modest rate cuts in 2024.

Arguably, much of the bad news has been priced into equity markets. The S&P 500 Index is down about 7% over the last 7 quarters, even though economic growth has remained positive. Markets sold off sharply in 2022 in anticipation of a potential recession and higher interest rates. the economy has been able to keep growing despite the highest rates in nearly 20 years. Inflation is trending lower, and the Fed is likely near the end of rate hikes and has shifted toward a higher for longer mandate. If the US can avoid a recession, it is likely that domestic stocks will move higher as they seem to have priced in a recession already.

International equities are buoyed by relatively attractive valuations and lower interest rates compared to the U.S. However, dollar strength in the third quarter reduced international developed market returns. The end of Fed rate hikes could prompt the dollar to decline from recent highs, which would be supportive of stronger returns overseas. Emerging market stocks are trading at discounts as well, and several countries have already started cutting rates as inflation has declined. The International Monetary Fund (IMF) is projecting emerging markets will expand at three times the pace of developed markets in 2024, which could lead to a recovery in emerging markets after several years of poor performance.

Bond yields are likely to remain fairly stable as the Fed is nearing the end of rate hikes. However, longer-term rates have risen recently as it now appears the Fed will not cut rates until mid-2024 and may not do so as aggressively as originally expected. Strong employment and inflation above the Fed’s target will prevent the Fed from cutting aggressively even if we enter a recession. Bond returns will likely be driven by yields rather than price movement for the remainder of the year. However, yields are relatively attractive and well above the current inflation rate.

This information is for educational purposes and is the opinion of Aldrich Wealth LP (“Aldrich Wealth”).  Facts and figures are believed to be from reliable sources, but no liability is accepted for any inaccuracies. Nothing in this commentary should be construed as an investment recommendation. Forward-looking statements expressed herein are subject to change. Past performance does not guarantee future results and all investments involve risk. Aldrich Wealth is an investment adviser registered with the U.S. Securities and Exchange Commission.