U.S. Equity Investment Environment
U.S. equity markets saw consecutive declines in August and September as investors grappled with ongoing inflation, fear of a government shutdown, rising interest rates, and the potential for a “higher-for-longer” rate environment. The S&P 500 experienced a disappointing quarter falling 3.3%, though remains up 13.1% year to date due to the outsize 70% contribution from the seven mega-cap stocks that also dominate the NASDAQ and accounted for its 27.1% gain for the year. The S&P 500’s energy sector performed best and was one of only two sectors up for the quarter posting a 12.2% gain, in response to geopolitical issues, high oil prices and projected shortages. Communication services, the other sector with a positive third-quarter return, ended the nine months up 40.4%, lead by Meta Platforms Inc. and Alphabet Inc. (two of the seven mega-cap stocks that drove the S&P higher). The S&P 500’s utilities sector experienced the steepest drop of 9.2% for Q3, to remain the weakest for 2023, down 14.4%. Smaller-capitalization issues continued to underperform due to higher interest rates as the S&P Small-Cap 600 tumbled 4.9% during the quarter, to gain 0.8% so far this year.
International Equity Environment
Foreign developed markets underperformed the U.S. with the MSCI EAFE Index down 4.1% for the quarter and up 7.1% year to date as investors worried about the negative effects of elevated interest rates on economic growth. Inflation moderated in Europe and the U.K. but remained well above central bank targets. The European Central Bank raised interest rates twice during the past quarter while the Bank of England raised its base rate once to 5.25% in August. The Bank of Japan left rates unchanged and, in spite of weakness in the yen, Japan’s equities lost only 1.6% in the quarter to finish the nine months up 11.2%, a marked turnaround. The U.K. performed relatively well, only down 1.5% over the last quarter, to end up 6.8% for the year. Emerging markets faired slightly better with a 2.9% loss for the MSCI Emerging Markets Index in Q3. China, the index’s largest component, was down 1.9% this past quarter. Its lackluster recovery continued to be impacted by problems in the real estate sector and a lack of significant policy stimulus.
Fixed Income Environment
The Bloomberg U.S. Aggregate Bond Index fell 3.2% in Q3 as the Federal Reserve announced one rate hike of 25bps in July and a “hawkish pause” in September, bringing the Federal Funds Rate to 5.25%-5.5%, the highest level since 2007. Policymakers hinted that another rate hike may be necessary before year end to tame still-high inflation. The annual CPI number reached 3.0% in June, its lowest rate since early 2021, before ticking back up to 3.7% in August. Concerns over rising U.S. debt issuance and the Fitch Ratings downgrade of the U.S.’s AAA rating to AA+ weighed on Treasury markets. U.S. Treasury yields across all maturities ended the quarter higher, most notably the rise of the 10-year Treasury yield to 4.59%, its highest since 2007. This resulted in a narrowing of the two- and ten-year Treasury spread to 0.44%. In response to higher interest rates, long-dated Treasury bonds dropped 11.8% in the quarter while floating rate leveraged loans with short maturities were up 3.0%. Municipal bonds disappointed as well as the Bloomberg Municipal Bond Index retreated 4.0% and turned negative year to date.
The S&P GSCI Index rallied 16.0% in the third quarter to finish the nine months up 7.2%. Energy has been this year’s top-performing commodity sector, up 28.8%, as Saudi Arabia and Russia cut oil production. Precious metals and agriculture lagged all other commodity categories down 3.8% and 4.4%, respectively, this quarter. Gold retreated 3.9% over the past three months, and is up only 1.3% year to date, primarily due to the continued strength of the U.S. dollar.