DWM’s 3Q23 Market Commentary: Good News Sometimes Equals Bad News

October 04, 2023

The US economy has been downright resilient. Check out that graph above showing how strongly earnings have grown over the last few decades. And analysts expect that trend to continue! The 2023 recession everyone was talking about has failed to materialize. Excitement for a “soft landing” manifests. Albeit, this “good” news actually is “bad” news for most markets as it means the Fed likely continues its hawkish stance thus “higher rates for longer”. For most assets - particularly longer duration assets - this is not welcome news. And that’s why, besides energy-related securities and cash and some alternative strategies, 3Q23 showed a lot of red.

Let’s take a look first at how the major asset classes have fared in 3Q23 and then talk about what’s next.

Equities: The S&P500 has fallen about 7% since its July highs. Higher rates aren’t good for equities, particularly for high growth stocks (like those found in the NASDAQ which was down 4.1% for 3Q23) that are often valued on their expected future earnings. Even the AI (Artificial Intelligence) rally has stalled out. When interest rates rise, investors demand higher returns to compensate for the increased risk associated with equity investments, which typically leads to a re-evaluation of stock valuations, causing PE ratios to contract. Higher rates are also bad for small cap companies (evidenced by the Russell 2000 being down -5.1% in 3Q23) that borrow more to fund their businesses. Higher rates also can make other asset classes (cash / money markets) look more attractive; as such, short terms traders may shift money away from equities to other areas. In general, for the quarter, most equity benchmarks were down about 3%-6%; and for the year, up anywhere from just a couple percent (Dow Jones up 2.7%) to double digits (S&P500 up 13.1%) if some/all of the “Magnificent Seven” – the biggest names in tech (Apple, Alphabet, Amazon, Microsoft, Meta, Nvidia, and Telsa) - are held.

Fixed Income: After a harsh 2022, many were calling for a reversal in bond land and expecting positive returns. Fixed income markets showed life early on in 2023 but have struggled of late evidenced by the Bloomberg US Aggregate Bond Index down 3.2% for 3Q23 and off 1.2% YTD. Why has it been so rough as of late? You guessed it – higher rates for longer. Yields have soared on that notion with the 10-yr Treasury now trading at levels not seen since 2007. Fortunately, a shortened duration stance has helped our DWM fixed income investors. Of course, fixed income returns have a lot to do with changes in interest rates – it’s math. To understand the importance of this, see the chart below. The big take-away here is that even if rates rise anther 1%, a medium term bond offering like the US Aggregate Bond Index shouldn’t lose much, perhaps 1% in total return because yields are now so high; but at the same time if you have a 1% fall in interest rates, that same index could see double-digit returns! Which is one of the reasons why we think fixed income is becoming more and more attractive as we get closer to peaks in rates, quite opposite of the stance we took a couple years ago before the big Fed hiking campaign got going.

Alternatives: This is an area that showcased some winners in 3Q23. Managed futures and other trend following strategies seemed to perform nicely. The Rational/ReSolve Adaptive Asset Allocation fund we follow climbed over 10%! Market Neutral strategies like the Victory Market Neutral Fund (up 2.9% 3Q23 & 4.2% YTD) generally fared well. Commodities*, in particular those related to energy, jumped about 10% as oil climbed to about $90/barrell. It should be noted that this wasn’t from a surge in demand but more about OPEC reducing inventory. Real Estate**, -7.9%, and gold***, -3.9%, were the major laggards. For the record, our preferred alternative benchmark, the Wilshire Liquid Alternative Index, posted a -0.2% 3Q23 and +2.5% YTD returns.

Putting it all together, a diversified portfolio was mostly likely down a little bit for the third quarter but still decently positive for a 2023 year which has seen many curveballs so far and yet still a quarter to go! Many of the ripple effects of Covid have settled down, but there are some still there! Yes, inflation has come down big time but prices are up from prepandemic levels, in some cases, way up! It amounts to a lot of pressure on the consumer which makes up roughly 2/3rds of GDP when you have those higher prices, escalating gas prices, and the resumption of student loan payments, and more. So consumers are starting to feel the pressure and so are companies.

It's a tight rope the Fed is walking here: trying to remain hawkish to get inflation back down to its 2.0% target level, in effect attempting to slow down what is currently a robust US economy, without downright killing it. The way we see it, there’s roughly a 50/50 chance that we get another ¼ point Fed rate hike in 2023 and then at some point in 2024 the Fed pivots and starts lowering rates. We see the economy cooling and it could be that the Fed has to accelerate its cutting notions, which again is one of the reasons why we are pounding the table on fixed income.

It should also be noted that while money markets and short-term CDs may look attractive, cash is never king for long. Many of our fixed income investments have shorter term vehicles like cash and cash equivalents that have really benefited from the higher yielding short end of the curve. But we’ll be sure those managers are managing that duration outward given how we see things unfolding. The graph below shows the reinvestment risk present in just holding cash, i.e. when rates peak, cash typically always underperforms the US Aggregate Bond Index and equities over the next twelve months.

In conclusion, 3Q23 proved to be a busy and challenging quarter. We didn’t even have a chance to really talk about the government shutdown that almost happened, the strikes happening amongst various industries, the US dollar resilience, and more. The fact is there are both tailwinds and headwinds out there – sometimes good news is bad news and bad news is good news, and it can be downright perplexing. Anxiety is understandle. Empirical studies show that staying invested with a diversified portfolio and staying disciplined to that approach works. Utilizing a trusted wealth manager like DWM can help you stay on course. Don’t hesitate to contact us for a consultation on your portfolio if you’d like assistance.  

Brett M. Detterbeck, CFA, CFP®


* represented by the Invesco DB Commodity Index Tracking

** represented by the Easterly Global Real Estate Fund

*** represented by iShares Gold Trust

Detterbeck Wealth Management is a fee-only financial planning / wealth management company with offices located in Palatine, IL (Chicago area) and Charleston, SC areas serving clients locally and across the country. To contact us about setting up an appointment, please see our contact us page