Q3 2023 in review
Tuesday, October 3, 2023
Additional content provided by Colby Hesson, Analyst
Equities took a hit in Q3 but are still strong to date.
The stock market has still had a solid year, but it fell in the third quarter. Following a nearly 5% drop in September, the S&P 500 sank 3.3% in the third quarter, with rising interest rates the main culprit in the decline. September weakness was nothing out of the ordinary given the month has historically seen some of the weakest market performance on the calendar. Style was not a differentiator, as the Russell 1000 Growth and Value indexes achieved roughly similar total returns. Despite the down quarter, the Nasdaq has maintained a strong year-to-date return of 27.1%, surpassing both the S&P 500 and the Russell 1000, both of which have returned about 13%.
Sectors take a hit, except energy
Energy was by far the best-performing sector last quarter and the only one that increased month over month. The sector benefited from higher oil prices as well as increasingly shareholder friendly producer behavior. With a 2.8% increase, the communication services sector finished second, led by Alphabet (GOOG/L) and Meta (META). Real estate and utilities, on the other hand, trailed with quarterly decreases of 9.7% and 10.1%, respectively. These income-oriented sectors were both hurt by higher rates with conservative fixed income options becoming increasingly competitive. Communication services (+39.4%), technology (+33.8%), and consumer discretionary (+25.7%) continue to lead the way year to date.
The US outperformed developed and emerging markets.
The US market outpaced the MSCI EAFE index by a slight margin, owing in part to the strength of the US dollar. This has been a trend throughout the year, with the United States being one of two countries to have climbed by 10% year to date. Japan was the other country to have a 0.8% increase. Without Japan, the Pacific was the lowest-performing major region, falling 4.1%. On the emerging market side, all three market regions showed minor decreases this quarter. EMEA dropped 1.8%, Emerging Asia lost 2.2%, and Latin America lost 2.7%.
Fixed income also struggled this quarter
The fixed income market struggled in the third quarter of 2023 as interest rates rose. With the Bloomberg Aggregate Bond Index dropping 3.2%, the domestic bond market recorded its worst quarter of the year. The rise in Treasury yields has pushed up most other corporate and consumer interest rates. Long Treasury bonds led the way down as the yield curve steepened, plunging 11.8%. High-yield bond volatility increased as investors focused on credit spreads and default risk.
The Fed might have made its last rate hike of the year
The Federal Reserve increased interest rates by 25 basis points (0.25%) in July, solidifying its position that it will base future rate hikes on facts. The Fed has aggressively increased short-term interest rates over the past 18 months or so in an effort to slow the generationally high rate of inflation. While the prognosis for the economy remained uncertain, the Fed and investors both continued to scrutinize economic data in order to learn about probable future policy changes and market conditions.
LPL Research’s latest thinking on asset allocation
The STAAC maintains its recommended neutral equities allocation based on the Committee’s assessment that the risk-reward trade-off between equities and fixed income is roughly balanced, with stock valuations still elevated and bonds offering very attractive yields. The Committee continues to slightly favor developed international stocks over U.S. stocks due mostly to valuations and increasingly more shareholder friendly management teams in Japan, but currencies have not been helping and Europe has clearly weakened. Key risks to equities include overtightening by the Fed, further upward pressure on yields, broader military conflict in Europe, and escalation in U.S-China tensions.
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