October 13, 2023
Most markets in both the US and internationally retreated in the third quarter following strength in the first half. Geopolitical concerns continued as the Russia and Ukraine conflict continues and there has been no thawing between the US and China.
Domestically, stronger indicators of economic growth, a resilient consumer, Fed policy and surging interest rates proved challenging for the markets. Internationally, growth concerns, central bank policies, and potential fall-out from China’s struggles proved to be headwinds for the markets.
Due to increasing concerns over recession risk we continued to reduce value exposure. However, we expect industrials to benefit from the transition to lower carbon emissions and funds beginning to flow from the Jobs Act, Inflation Reduction Act, and the Chips Act as we move into the end of the year and into 2024. We added to international growth, which continues to exhibit solid earnings growth this year with expectations for continued growth into 2024. The drawn-out downturn of property markets in China shows few signs of improving, major developers are struggling, and new home sales are falling dramatically. Local governments’ options are limited given their heavy debt loads. In addition, the Chinese Communist Party seems unwilling to make the major incentives needed as that would highly leverage their balance sheet. As a result, we have eliminated China exposure as this appears to be a longer-term turnaround following what appeared to be an improving situation earlier this year. Energy prices, as measured by West Texas Intermediate (WTI), broke out to the upside of their trading range for the year, driven by strong demand and announced reductions in supply by Russia and OPEC. As a result, energy holdings did well in the quarter. Emerging and international developed market holdings struggled in the quarter due to a strengthening dollar.
Over the course of the quarter interest rates moved significantly higher due to stronger economic metrics and Fed commentary on the strong possibility of rates remaining higher for longer. The 10 Year Treasury moved from 3.8% on June 30 to 4.6% at quarter end. We used the move up in rates to add to our fixed income position.
In the US, while recession may have been deferred this year, we do not believe it has been diverted. We expect a significant slowing in profit growth and corporate profit margins are likely to be pressured. Developed international markets, by comparison, may experience stronger profit growth and currently have attractive valuations relative to US markets. Inflation has slowed broadly and any easing of demand may provide relief to central banks’ policy broadly. We believe the diversified portfolio will serve clients well in this developing environment.